Lex is a premium daily commentary service from the Financial Times. It helps readers make better investment decisions by highlighting key emerging risks and opportunities.
Why would a company create a new subsidiary to do what the rest of the company already does? Assured Guaranty, the bond insurer, unveiled a new, um, bond insurer last week. Called Municipal Assurance Corp, or MAC, it will insure U.S. municipal bonds. The idea seems to be that MAC will be untainted by the bad mortgage guarantees that its parent wrote before the financial crisis.
The bond insurance industry was damaged by its expansion from dull munis into risky mortgage debt. Bond insurers' capital was eroded by mortgage defauts, their credit ratings fell, and the value of the protection they sold followed suit. Prices of insured muni bonds fell, parts of the market froze, and soaring interest rates pressured municipalities.
Of the six insurers that existed before the financial crisis, almost all have either failed or are in runoff. Assured is the only one still insuring new bonds. The other active insurer is Build America Mutual, which was formed only recently and is owned by policyholders. Demand for bond insurance has plummeted. A decade ago more than half of new muni bonds were insured. Now fewer than 10 per cent are – not suprising, given how the industry failed its customers during the crisis.
But the ultra-low interest rates of the last few years – since 2011, top-rated 10-year general obligation bonds have averaged about 2 per cent – have also left little room for premiums. A rise in rates offers some hope for a revival. But the fallout from Detroit's bankruptcy could also have a big effect, for good or ill. Should Detroit presage more defaults or even just raise concerns of them, it could boost bond insurance demand. But if the insurers wind up paying out a flood of claims, profits would of course suffer. Finally, some of Detroit's bonds are insured; if the insurers prove unable to pay, it will be another hard blow to the industry.