Is bond insurance coming back?
One of the more prominent casualties of the financial crisis the bond insurance industry. Before 2007–for a modest fee–issuers could have a third party evaluate their credit and underwrite their bonds. By virtue of low default and high recovery rates among the insured, insurers’ capital could transform otherwise marginal credits into AAA bonds.
70% of munis are held by individuals, so it seemed like a perfect business. Investors would buy the bonds; the insurers would do the analysis. But the insurers tried to expand, and the model that worked so well with munis blew up with mortgages. They were all downgraded, and then no one cared about bond insurance. Some insured bonds actually traded at higher yields than uninsured counterparts–for the same credit!
But it looks like people are beginning to care again. Detroit’s 18 billion-dollar bankruptcy has gotten investors’ attention. While the city and other bond issuers–Yankee Stadium parking lot bonds come to mind–may suspend payment of principal and interest, insured bonds keep right on paying. The insurer is on the hook, and unless there’s a haircut, they’ll eventually get paid back.
It’s one more way the financial markets are showing signs of healing. It’s just ironic that for the marketplace to get better, a big borrower has to get sick.
Douglas R. Tengdin, CFA
Chief Investment Officer