When I put up a post about bond insurance and default rates last week, I expected pushback from proponents of municipal insurance. I got some.
Events in the last seven years show anecdotal evidence for and against municipal bond insurance. The bankruptcies of Jefferson County and Detroit and the workout of Harrisburg, Pennsylvania demonstrate the value of a bond insurer that makes full interest and principal payments for defaulted bonds. Investors undoubtedly benefit from this continuity of payments.
In contrast, we have the financial collapse of 2008, when most bond insurers were downgraded below the level of the issuers they had insured. The issuers started trading on their underlying ratings, and as far as I know, they were not refunded for the insurance premiums they had paid upfront. In a big financial crisis, bond insurance is a bust.
Mark Palmer of BTIG addressed another dimension of bond insurance; the lowered borrowing cost that AA-rated bond insurers (Assured, MBIA and BAM) can pass onto the new bonds that they insure. Palmer writes:
Bond insurance prevents payment interruptions for insured investors and allows them to avoid the protracted and difficult recovery process following defaults when they do occur, which are rare for higher-rated bonds. However, the primary purchasers of bond insurance are the issuers of municipal bonds – the municipalities themselves. And municipalities gain several benefits from insurers’ wraps, including lower borrowing costs due to improved execution, capital market access – a key benefit for issuers that otherwise would have limited or no ability to float bonds without credit enhancement – and the surveillance and intervention that insurers provide.