Boston-based research firm Aite Group has released a new report about municipal bonds which outlines the changes wrought on the muni market during the financial crisis.
“Things have changed dramatically,” says John Jay (left), senior analyst at Aite Group and author of a new report on the state of the states and municipalities that make up the municipal securities market in America. The report, “Municipal Bonds: Not Your Father’s Market,” is a primer on the basics and current trends of the municipal securities market. Jay discussed his findings in an interview with AdvisorOne.com on Wednesday.
Lack of AAA-rated Supply
“For municipal bond fund shareholders, there is a dearth of bond availability…[there are] no longer enough AAA-rated bonds,” Jay explains. Why? Because there are relatively few bonds that are rated AAA based on the creditworthiness of the underlying municipality or state—whether their tax revenues can cover the bond payments sufficiently. Munis have been a haven for investors, with tax exemptions and because the AAA-rated general obligation bonds of states, municipalities or towns were considered very safe since they had the power to raise taxes, if necessary, in order to pay off the bonds.
“The balance sheets of the municipalities or the states,” he says, have been hit very hard by the crisis, with unemployment, home valuations down and accompanying tax revenues diminished. Many more AAA-rated munis relied on bond insurance to get the AAA rating—insurance which covers a much lower fraction of the muni market now, according to the report.
Without the insured AAA-rated muni supply, Jay contends that muni bond funds that “promise an average of AA+ or better-rated bonds” in the portfolio are having trouble finding supply, and are “shrinking.” There’s a “big class of investor out there that looks to the tax exemption as an important part of the investment decision.”
Muni Bond Insurers Suffered Big Setbacks
The decrease in the issuance of insured municipal bonds is in large part a result of bond insurers’ respective forays away from insuring munis. Most of the muni insurers—referred to as monoline insurers—broadened their scope to insure structured products, many of which defaulted and cost them dearly during the financial crisis. In addition, portfolio managers discounted the value of such insurance during the crisis, preferring to value munis based on a municipality’s underlying balance sheet.
Monoline insurers like MBIA, AMBAC, FGIC ACA, FSA “have ceased to insure municipal issuances altogether” the report states, adding that Berkshire Hathaway Assurance Corp. insures a small portion of the munis that are issued with insurance, and Assured Guaranty “dominates” the market for insurance on muni bonds, “with roughly 90%” of the market. According to the report, about half of the munis issued in 2007 were insured, while in 2010 it’s down to about “8%.”
AMBAC in Default
AMBAC had a net loss of $57 million in the second quarter of 2010 versus a net loss in the 2009 second quarter of more than $2.3 billion.
AMBAC is widely reported to be considering bankruptcy; The Wall Street Journal reported Tuesday that AMBAC “said its board had voted to skip an interest payment on senior notes due in 2023. The payment was due to be made Monday; if the insurer hasn't paid in 30 days, it would be in default.”