Tuesday, November 20, 2007 0 comments ++[ CLICK TO COMMENT ]++

Muncipal Bond Insurance Market Still Looking Strong

Municipal Bond Buyers Still Using Bond Insurance

According to Joe Mysak of Bloomberg.com, the market is still receptive to bonds insured by the monolines.

At a time when nobody really knows if the nation's major bond insurers will still be rated AAA in a couple of months, municipalities are lining up to get their bonds insured. Investors, evidently, are buying them.

Last week, more than half of the issuers who sold bonds got their deals insured.

This is exactly the proportion of bonds that are normally insured during a given year, at least recently.

This means that the primary business of most monolines, which is to insure municipal bonds, is still functioning. One of the concerns for any monoline investor is whether sales will decline due to customer anxiety over their viability. According to this article, things are still looking good. If I were to invest in Ambac (ABK), one of the things I would want to be certain with is that customers don't avoid the market. Some bears claim that bond insurance is not needed and these companies should go to zero but I obviously disagree.

Insurance On Top of Insurance

The author also goes onto to mention that some customers are insuring on top of existing insurance:

An especially interesting phenomenon is occurring in the secondary market right now. Last year at this time, seven blocks of bonds that hadn't been insured at all when they were first sold, were insured in the secondary market, by MBIA, according to Bloomberg data. Getting bonds insured in the secondary doesn't happen a lot, but it's not unheard of.

Especially now. So far this November, 64 blocks of bonds have been insured in the secondary market, only now it looks like some investors are getting their already-insured bonds insured by someone else, just to make absolutely sure they stay AAA.

MBIA insured three blocks of bonds insured by FGIC; the bulk of the business, however, was done by FSA, which has insured more than 50 blocks of bonds already guaranteed by Ambac and FGIC.

Well, there is the good news; and the bad news. The bad news is that the market, at least the bond buyers, really perceive a risk of some collapse in the bond insurers. Buying insurance for already insured bonds seems like the dumbest thing ever but... the positive in this is that, as I mentioned above, the market really sees a need for bond insurance. Maintaining a AAA rating is really valued by the market (this shouldn't surprise anyone given that some institutional investors can only own AAA-rated bonds). Contrary to what some bears claim, the long term future of this industry looks strong. The only question is the near-term outlook--and who will survive?

Warren Buffett & Bond Insurance

The author also goes on to say that Warren Buffett should enter the municipal bond insurance business. This would present a huge competitive force to the existing monolines but it is a possibility. The spreads on risky assets are rising and insuring them is right up Warren Buffett's alley. I still think that Warren Buffett may end up writing reinsurance for some of the monolines if their rating is under threat. Backstopping the monolines seem to offer an easier route for Buffett than entering a market with low brand recognition (I'm not familiar with Berkshire Hathaway but I believe they don't write much, if any, bond insurance) and human capital (people matter in this business).

All I know is that if Buffett ever gets involved in this sector, the stock prices of Ambac, MBIA, etc, are going to skyrocket. It will signal to the market that writing new business is worthwhile. It still won't solve the existing, potentially disastrous, exposure to MBS, CDOs, and so forth, but it will provide some clarity for the future. But it will be a slight negative in the long-run since it will introduce a formidable competitive foe. If Ambac and/or others survive, I think the long term future potential is large. Hardly anyone uses bond insurance outside North America and Europe (and possibly Japan--not sure). I can see it being endorsed in developing countries in Asia and Eastern Europe, among others, for infrastructure projects. Investors not too trusting of foreign governments may want the wrap protection of the monolines.

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