Analysis: Detroit crisis may give lift to muni bond insurers

Sun Aug 11, 2013 8:10am EDT
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By Edward Krudy

NEW YORK (Reuters) - At first glance, it is hard to see Detroit's bankruptcy filing as anything but another body blow for downtrodden U.S. municipal bond insurers, which could be on the hook to investors for hundreds of millions of dollars in losses on the city's debt.

But the city's fiscal upheaval may in fact have the opposite effect - providing the marketing spark needed to revive a business decimated by the financial crisis like few others.

For issuers that have mostly gone without coverage since the 2007-09 financial crisis hammered most bond insurers, Detroit's filing may serve as a stark reminder of the wisdom of buying insurance. Put simply, insurers' payment guarantees make their bonds more attractive to investors.

"Investors are going to see the benefit of insurance in action more and more," said Alan Schankel, head of fixed income research and strategy at Janney Capital Markets. "I think this is net-net a positive marketing story for bond insurance."

Once a familiar fixture, bond insurance gave extra financial security to bondholders, including the retail investors who hold almost half of the $3.7 trillion market, while helping local issuers lower borrowing costs.

Before the crisis, about half of all new municipal bonds had insurance from nine insurers, with nearly 60 percent covered in 2005. Last year, just 3.6 percent were insured, and this year the number is just over 3 percent, Thomson Reuters data shows.

Bond insurers collapsed during the financial crisis after they ventured into mortgage-backed securities in the years before 2007. Ratings agencies slashed their AAA ratings to junk or withdrew them altogether. That meant bond issuers no longer benefited from their coverage.

With insurers failing to make promised payments, their stock tanked and so did their businesses.   Continued...

Downtown Detroit is seen looking south on Grand River Avenue in Detroit, Michigan July 25, 2013. Photo taken July 25, 2013. REUTERS/Rebecca Cook