Assured should seek a new credit rating
Moody’s released it’s long awaited opinion of Assured Guaranty’s creditworthiness on January 17th. Moody’s analysts were not feeling good about the subsidiary that insures the bonds of municipalities. They pushed the rating down three notches from Aa3 to A2. The Bond Buyer noted that “fundamental challenges inherent in the business model make a return to the Aa rating level unlikely.” Zap and you are dead.
In the municipal bond insurance space, firms make money by insuring (or wrapping) bonds of communities or public entities that have lower credit ratings. This saves money for the entity issuing the bonds because it has a lower cost of borrowing and the insurer is guaranteeing that they will repay investors if the bonds default. It also benefits the investors who know that they will be made whole if the issuer cannot make payments on their bonds.
However, when a bond insurer’s rating is lowered, that means the pool of bonds it can insure shrinks because many new bonds have higher credit ratings. Assured now has a lower credit rating than most bonds being brought to market.
Bond insurance has been fading since 2005 when 57 percent of new municipal bonds were insured. In 2012 only 3.5 percent of newly issued bonds – or about $13 billion in new debt - were insured. Muni insurer names that were once the gold standard, Ambac, MBIA and FSA, have either gone bankrupt, been absorbed or are struggling with a junk credit rating. Assured is the last muniland bond insurer standing and it’s unclear how they can continue to write new business.
Assured was obviously upset at Moody’s for knocking down its credit rating (and business model) three notches, and it responded with an eight-page defense of its business and capital adequacy. Insurers are a bit of a black box. For example, Assured has had substantial swings in the fair values of credit default swaps and there are likely other mysteries on its balance sheet that Moody’s parsed through. Here is a bit from Assured’s rebuttal to Moody’s:
If we look at the three years since our last detailed Moody‘s review, when AGM and AGC were assigned ratings of Aa3, we have materially increased our financial strength while significantly decreasing our insured exposures. During this period of global financial stress, Assured Guaranty produced a total of $1.8 billion in operating earnings.
We increased statutory capital by $1.4 billion and decreased our statutory insured par in force by $116 billion, which included an $11.1 billion reduction of U.S. residential mortgage-backed securities (RMBS). Currently, 22% of our remaining U.S. RMBS par exposure is covered by loss mitigation agreements, further protecting Assured Guaranty‘s capital.
Our solid capital position and decreasing exposure over this time period has also resulted in a 38 percent reduction in our insured leverage. We also held total claims-paying resources at approximately $12.5 billion even after paying over $3.0 billion (before R&W recoveries) to protect policyholders. These strong results certainly should have led, at a minimum, to a rating affirmation.
It’s important to remember that credit ratings are merely opinions. They are often dressed up as having quantitative models underlying them, but in the end a rating agency makes a qualitative decision about the creditworthiness of a firm. If Assured, an insurance firm and a financial institution, disagrees with Moody’s, it can seek credit ratings from many other agencies including A.M. Best, DBRS, Fitch or Kroll. Assured currently only uses Moody’s and Standard & Poors as raters. If Assured is as financially stable as it claims, it needs to get new ratings. Markets are about confidence, and Assured needs to build all the confidence it can.