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: