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AMERICA’S municipal-bond market is worth around $2.8 trillion. But “monoline” insurers, which insure municipal bonds issued by American cities and counties, are barely breathing. On November 1st the industry edged closer to extinction when one of the largest bond insurers, Ambac, announced that it would skip an interest payment. The company could file for bankruptcy by the end of the month.
It didn’t need an oracle to predict Ambac’s demise. Earlier this year a state regulator siphoned off some of Ambac’s most toxic assets and put them into “rehabilitation”. Ambac has over $1.6 billion in debt, but only $76m in cash and short-term securities. One of its most coveted assets is its $7 billion “net operating loss tax carry forward”, which could translate into $2.5 billion in tax savings if it ever manages to turn a profit. Rob Haines of CreditSights, a research firm, does not think it will: “Ambac is a dying company with a finite life.”
The prospects for other monoline insurers look equally bleak. The industry got going in the 1970s and at first provided insurance only for municipal-bond issuers, which rarely defaulted. Over the past decade, however, the industry has branched out into structured products, such as risky mortgage-backed securities and collateralised-debt obligations. Big mistake. When subprime mortgages soured, bond insurers such as Ambac and MBIA, another embattled monoline, were on the hook to pay up. Their credit ratings dropped, which meant issuers were less willing to buy insurance from them.
In 2005 bond insurers covered around 57% of new bond issuance, but now they cover a mere 7% or so. Only one monoline remains active: Assured Guaranty, which sat out most of the structured stampede. All its pre-crisis peers are either being restructured, face litigation or are out of business. Even Warren Buffett, who entered the bond-insurance market in 2008, has pulled back. “We’re like an only child,” says Dominic Frederico, the boss of Assured Guaranty. “We don’t have anybody to play with but all the toys are ours.” Still, life isn’t all fun and games. Standard & Poor’s, a ratings agency, last month stripped the firm of its AAA rating.
Some still believe there is hope for the industry. The National League of Cities, a non-profit organisation, thinks there should be a mutual insurance company owned and operated by local governments. But monolines will have to embrace a new model to succeed. Stanislas Rouyer of Moody’s, another ratings agency, says monolines need to emphasise that they provide not just insurance but also monitoring and surveillance capabilities. This would enable them to sell their wares directly to retail investors, who account for 36% of the buyer base for municipal bonds.
There are other hurdles to jump first. The shaky finances of some municipalities could put what’s left of the industry to another huge test. Fragile issuers and nervous investors ought to be a boon to insurers. But mass defaults by cities and counties could be the final blow for Assured Guaranty and its zombie peers.
