Can the Bond Insurers Survive?
The "B" word shows up in earnings and news reports.
Two of the nation's largest municipal bond insurers are skating on such thin ice that some securities analysts are skeptical of their ability to survive in their current corporate form. Shares of AMBAC and MBIA stock tumbled Tuesday on concerns that they will not survive the housing rout without federal intervention or bankruptcy.
Earlier this decade, both companies strayed from their core businesses and, as the fiscal crisis of 2008-2009 played out, watched their reserves dwindle and their stock prices plunge from former peaks. But, unlike other financial services companies whose share prices have recovered substantially from the lows earlier this year, municipal bond insurers continue to struggle in the marketplace.
With ratings declining to levels that make their guarantees of municipal bonds worth less to investors, their ability to write new business is impaired. In a recent Securities and Exchange Commission filing, AMBAC declared it may seek bankruptcy protection, according to Bloomberg News. MBIA reported a third-quarter loss of $700 million, and some analysts question the company's claims that its reserves will be sufficient.
Do we need a federal bond insurer? Earlier this year, I wrote a column endorsing the concept of a federal credit enhancement facility. Back then, Representative Gerry Connolly of Virginia introduced a bill that would provide a backstop for municipal credit guarantors. House Financial Service Committee chairman Barney Frank was working on a similar bill.
It now looks like the time has come to dust off those bills to get them moving quickly through the Congress. Swift Congressional action might even save one or more of the current firms by providing a secondary backstop guarantee to their privately insured paper. I would support such federal intervention, although many political pundits oppose federal bailouts of financial companies after the TARP experience of the past year. Taxpayers and voters may grudgingly understand the need to prevent big banks from failing, but they don't necessarily feel the same way about municipal bond guarantors.
Spillover into other market sectors. In addition to their primary business line of insuring municipal bonds, these firms have taken on other sideline businesses that may impact local governments if they were to fail. For example, MBIA provides money-management and investment advisory services to municipalities. A credit collapse or corporate action by the parent could have business-continuity implications for the subsidiary and its customers -- even though a locality's cash invested by third-party investment advisors is typically held in securities safe-kept by independent custodians. If conditions in the municipal bond insurance marketplace worsen, prudent officials who are impacted will probably exercise keener vigilance including tight review of custodial reports to ensure portfolio safety. (Full disclosure: The author is employed by a firm that competes in the investment advisory sector.)
Professional associations representing local governments need to step up to the plate now and express an orchestrated point of view on whether they support federal intervention to provide guarantees on municipal bonds. Although the marketplace has begun to stabilize after a dreadful start earlier this year, the absence of a viable guarantor will drive interest rates higher for marginal credits. And with cash positions still weakening in this economic malaise, this news could not come at a worse time.
To resuscitate the municipal markets, we need a temporary, 18-month federal guarantee provision similar to the one proposed by Connolly or federal seed capital for a cooperative credit enhancement consortium as proposed by the National League of Cities and the National Association of Counties. Without a means to enhance their ratings, localities with credit ratings of "A" and below will find it difficult and costly to proceed with the public projects that are key to job recovery through the stimulus program. White House, take note.
Girard Miller's general market observations and institutional investment strategies are his own and not those of affiliated organizations, and should not be construed as investment advice or recommendations concerning specific securities.
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