While still a shadow of its former self, the bond insurance industry is showing signs of revival amid a pickup in issuance of deals backed by riskier assets.
However, the credit rating agencies, which misjuded insurers' ability to guarantee payments in the past, have become much stricter gatekeepers.
Of the nine bond insurers active before the financial crisis, only one, Assured Guaranty, is still wrapping insurance guarantees around the senior portions of structured bond deals. Assured is rated 'AA-' by Standard & Poor's and 'Aa3' by Moody's Investors Service.
MBIA, once the top dog in the monoline insurance business, is in the midst of litigation over a restructuring plan. Assuming the lawsuits are resolved in its favor, MBIA plans to relaunch its municipal bond insurance business, now called National Public Finance Guarantee, and later pursue wrapping structured finance bond deals. MBIA is rated 'B-' by S&P and 'B2' by Moody's, which has placed it on watch for a possible downgrade.
The other seven companies are in bankruptcy proceedings or are running off assets and winding down. For now, that leaves Assured Guaranty as the sole contender for bond insurance mandates. This is happening just as the structured finance market is tallying healthier volume numbers. As proof, Barclays Capital analysts expect total ABS issuance to reach $125 to $140 billion in 2012, increasing from an initial projection of $100 to $115 billion.
Smaller, less seasoned issuers are also setting foot into markets such as subprime autos and esoteric assets in an effort to take advantage of investors' hunger for higher yields. Those issuers, looking to burnish their credit and draw more investors, are bond insurers' bread and butter, and some market participants have taken notice of the trend.
"I've spoken to a couple of parties this year that would like to get into the [bond insurance] business," said Mark Palmer, who analyzes the industry for institutional brokerage BTIG.
Palmer added that those early initiatives may carry weight since the executives had significant experience in the insurance and specifically the monoline businesses, although he didn't know who they currently represented. He added that at least one of the groups was interested in pursuing both muni and structured business.
A rumor recently circulated that Goldman Sachs was considering entering the monoline business. This started after a March 18 Financial Times article referred to job posting on the investment bank's Web site for an individual with financial-guaranty expertise. However, a person familiar with Goldman's plans said that while the firm was seeking someone to do market research, it has no plans to enter the sector. Goldman's single-A rating by S&P and 'A1' rating by Moody's might make such an endeavor practically impossible anyway, since the incremental risk that a lower-rated insurer poses diminishes the value of its guarantee. In fact, before the crisis, 'AAA' ratings were the standard among bond insurers.
The American Municipal Bond Corp., or Ambac, wrote the first monoline wrap in 1971 to guarantee the timely and regular payment of principal and interest on bonds issued by Juneau, Alaska. In the early 1990s, as more competitors entered the market and bond insurers looked to diversify, Ambac began insuring other types of bonds, including structured deals. In the years before the financial crisis, it was wrapping highly leveraged CDOs backed by MBS that in turn were backed by some of the riskiest mortgages.
When the mortgage market collapsed, most of the monolines did too. Assured Guaranty, at the time one of the smaller ones, survived the financial crisis. Moody's downgraded Assured's financial strength rating to 'Aa3' from 'Aaa' in November 2008, and its insurance operating companies were also bumped down a notch to 'Aa3'. But the firm has continued wrapping its guarantees around mostly private ABS deals, often smaller transactions from less well-known issuers.
"Assured never had a quarterly loss during the financial crisis, in part because it avoided the worst of the worst deals," Palmer said, adding that the insurer's underwriting standards have remained stringent.
Palmer noted that Assured generated approximately $243 million in new business production revenues in 2011, and $67 million of that stemmed from structured finance. The firm hit something of a milestone in January when its guarantee for the $96 million senior portion of a LEAF Financial equipment lease securitization was rated 'Aaa' by Moody's - or three notches above Assured's own rating. DBRS, from which Assured has sought ratings for most of its deals in recent years, granted the equivalent 'AAA' rating to the senior portion of the LEAF deal.
"The presence of a highly rated guarantor provides a strong form of support in the form of oversight that in our view goes beyond the actual financial guarantee policy," Moody's noted in its presale report for the deal, LEAF Receivables Funding 7. "This oversight mitigates operational risk in a highly effective way that is not directly linked to the financial strength rating of the guarantor."
Michael Labuskes, a Moody's analyst and the author of the report, went on to say that the guarantor will be motivated to monitor the transaction and use all tools at its disposal to address operational or performance problems that arise.
Paul Livingstone, senior managing director at Assured, noted that before the financial crisis, the monolines were typically rated 'Aaa', and the deals they wrapped carried the same top rating as the insurer, which guaranteed scheduled interest and principal payments on the bonds. As a result, there was little transparency into how the rating agencies arrived at their decisions about the underlying rating.
"What's interesting and positive from our point of view is that based on our involvement in the LEAF Financial transaction, Moody's was able to rate the deal above both our financial strength rating, and the issuer's ceiling, because they recognized that we do enhance the value of the issuer," Livingstone said.
Livingstone said that, in addition to proactively performing surveillance on the wrapped transaction, Assured receives periodic reports from the issuer and can meet with management and look at audit files whenever necessary. In addition, the indenture includes a contractual obligation for the issuer to request approval from Assured, as the controlling party, to pursue significant actions such as changing servicers.
An analyst who declined attribution due to firm policy noted the difficulty in building a significant quorum of investors to work out solutions when problems arise. "So if a deal is wrapped, a monoline is actively monitoring the deal, and if it runs into issues, the insurer can more proactively address those issues and employ covenants designed to do that," the source said, noting that that has long been a major strength of a monoline guarantee. "That's one thing that's going to be highlighted when the ABS market comes back."
The higher rating "shows investors the other ways we can add value to a transaction beyond the pure insurance," Livingstone said, adding that Assured has continued to provide similar wraps around traditional private ABS deals throughout the financial crisis. In other words, Assured has never stopped wrapping structured finance deals, but most of them have been traditional private transactions and not 144A deals.
The Moody's report said the ratings of LEAF's notes would likely be unaffected by even a multi-notch downgrade of Assured. "Should, however, the policy be terminated or the guarantor be downgraded to below investment grade, we would revisit the role played by the guarantor in mitigating operational risk as it relates to our rating of the notes," Moody's stated. Moody's claim may soon be tested. On March 20, it said it was putting Assured and its various affiliates on review for a possible downgrade. The ratings agency cited a decline in Assured's share of the municipal market to 5.2% from 8.6% in 2009. It also noted the continued economic stress in the U.S. and in Europe, which it said was impacting the insurer's portfolio, and pressure on new business margins due to low interest rates and tight credit spreads.
Assured responded April 13 by pointing out that, a week after putting the insurer on review, Moody's updated its credit opinions on the firm's subsidiaries, focusing on the municipal and structured markets. According to Moody's own Financial Strength Rating Scorecard, "both subsidiaries have earned strong 'Aa' ratings," Assured responded in a note posted on its Web site regarding Moody's concerns.
The insurer added that it does "not believe that a potential downgrade based primarily on concerns about origination volume and future margins (neither of which are relevant to a financial guarantor's financial strength rating) appropriately reflects Assured Guaranty's fundamental claims-paying ability."
Moody's is not the only credit rating agency taking a harder look at bond insurers. Last year, S&P adopted new criteria for rating bond insurers, including industry risk, competitive position, management and strategy, capital adequacy and investments. In December, S&P lowered its counterparty credit ratings on Assured's insurance subsidiaries to 'AA-' from 'AA+', putting its ratings on par with Moody's.
Nevertheless, Assured is currently the only bond insurer in town, and while ABS deals are currently structured conservatively, with significant subordination and credit enhancement, the arrival of new issuers appears likely to elevate the need for its services.
"The ABS market is slowly rebounding, and our pipeline is picking up as well," Livingstone said. "We have a pipeline of deals that are similar to the LEAF Financial transaction."
