Because to Covid-19, state and local borrowers are using insurance at higher rates than they have been in over a decade. Insurance companies pledge to pay investors if the municipality defaults under this sort of upfront protection. According to Municipal Market Analytics data, the share of newly issued muni debt carrying insurance increased to 7.13 percent in the second quarter and 6.8 percent in the third quarter, up from an average of 4.72 percent in the decade before to the pandemic.
How much of the muni bond market is insured?
For one thing, according to Bob DiMella and John Loffredo, co-heads and co-chief investment officers of MacKay Municipal Managers, the initial analysis of muni defaults was done at the height of Covid-19 shutdowns in March. In the meanwhile, not every market niche has been squeezed. Public utilities have fared well, and public schools should profit from the housing market’s sustained strength. Pension plans, on the other hand, have benefited from the rising stock market.
Municipal bonds with an insurance wrapper, however, may be worth a closer look for many investors, particularly those who buy and hold individual bonds.
“It’s a belt and suspenders bond,” DiMella explains. “You have the underlying credit, as well as this financial guarantor as a backstop.”
Bond insurance, as the name implies, ensures that the principal and interest on a municipal bond be paid if the issuer defaults. Before the financial crisis, DiMella notes, such insurance was widely employed, with a handful of companies insuring around 60% of all new municipal bond offerings.
“After the crisis, it literally plummeted off a cliff,” he says, with insurance wraps accounting for a miniscule percentage of the market.
Insured municipal bonds had been slowly resurgent in recent years, but the Covid-19 outbreak has sparked renewed interest, with insured munis accounting for roughly 10% of new muni bonds. To assuage investor concerns about rating downgrades and defaults, more major and high-quality issuers are including an insurance component in new bonds. Most bonds are now insured by two companies: Assured Guaranty and Build America Mutual.
Investors gain from stable ratings, better liquidity, and lower volatility, according to Loffredo.
Of course, insurance is never free. For muni bonds wrapped with insurance, investors will often give up between 10 and 20 basis points (1/10th and 1/20th of a percentage point) of yield. While some investors may object at this tradeoff, particularly in a low-yield situation, buy-and-hold investors may find it well worth their money.
“You don’t have to give up a lot of yield to receive the benefit of stable cash flow,” Loffredo says, adding that high-net-worth clients and family offices have recently showed an increased interest in insured munis.
While municipal bond insurance is a low-cost option for investors who keep bonds until they mature, active investors may benefit from price appreciation.
“We would argue that there is far more value today than there was at the start of the year,” DiMella says. “They’re wider in many situations than they’ve been in many years.”
Almost every section of the muni market was hit when the market first went off this spring. Insured munis recovered faster than comparable bonds, although spreads for triple-B-rated insured munis are still greater now than they were at the start of the year.
In fact, the guaranteed index’s gap over 10-year Treasuries started the year at 20 basis points and quickly grew to 190 basis points during the spring market turmoil. They’ve now reduced to 99 basis points, but the spread is still wider today than it was before the crisis, implying that rates will fall and bond prices will rise.
Insurance firms engage in municipal bonds for a variety of reasons.
Municipal bonds have traditionally been viewed as a relatively dependable source of high-quality yield by US insurers. These market conditions highlight the importance of having professional municipal debt expertise to understand market opportunities and prevent potential pitfalls.
In 2020, are municipal bonds a decent investment?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
What exactly are Bam municipal bonds?
Build America Mutual Assurance Company (abbreviated as BAM) is a mutual, monoline bond insurer specializing in vital public-purpose municipal bonds in the United States. The company has guaranteed over $65 billion in par amount for over 3,300 member-issuers since its launch in July 2012. It insured $8.36 billion in par in 653 new-issue insured transactions in 2018. BAM also discloses and updates credit profiles for each transaction it covers. There are now almost 6,000 available. The firm is the preferred source of debt financial guaranty insurance for National League of Cities member municipalities. When BAM was first released, the NLC endorsed it.
What factors go into determining an insured bond rating?
Municipal bond insurance policies can be purchased from private companies by issuers who meet specific credit conditions. If the issuer defaults on a bond issue, the insurance ensures that the principal and interest will be paid. Bond ratings are based on the insurer’s credit rather than the issuer’s underlying credit. Depending on the issuer’s underlying credit and market conditions at the time of the bond sale, a municipal bond insurance policy is designed to result in significant interest cost savings. The lower interest costs are due to the improved bond rating as well as the increased liquidity of protected bonds.
In 1971, triple-A municipal bond insurance became available.
Between 1971 and 2007, the number of insured concerns skyrocketed. In 1980, only 3% of bond issuance were insured; by 2007, that figure had risen to almost 60%. Municipal bonds were worth an estimated $2.5 trillion in 2008, with more than half of them guaranteed. As insurance has grown in popularity, so has the number of insurers. AMBAC was the first insurer, and additional triple-A rated insurers followed. Furthermore, insurance companies with a claims-paying ability lower than triple-A entered the market to provide coverage for bond issuance that were too small, atypical, or had credit conditions that did not match AAA insurers’ criteria.
Many Municipal Bond Insurers also covered collateralized debt obligations in addition to municipal bonds.
Due to subprime mortgage exposure, insurers’ credit ratings have been scrutinized since 2007. This vulnerability jeopardized the insurer’s capacity to pay claims, resulting in rating downgrades. Seven insurers were rated triple-A by the three major rating agencies in 2007. None of the insurers are now triple-A rated.
The bond insurers with the highest ratings in 2009 were Assured Guaranty Corp. and Financial Security Assurance. Financial Security Assurance was acquired by Assured Guaranty Corp on July 1, 2009. (See below for ratings.)
Build America Mutual Assurance Company (“BAM”) received its license in July 2012. Only vital public purpose issues will be insured by BAM. Standard & Poor’s gives BAM a “AA” rating.
Is it possible to lose money on municipal bonds?
These funds have a low risk of losing value, and the interest they pay is consistent. They also pay a very low interest rate as a result of their safety. Risk and reward are inextricably linked: a lesser risk equals a lower payoff.