Archive: Business & Technology

Bond insurance typically helps provide additional protection from default to a tax-free municipal bond. Until eight months ago, if the bond insurer was rated AAA by Standard & Poor’s (S&P), there was little thought given to the underlying bond issuer’s credit quality. However, because the bond insurance industry looks very different today, you need to look closer at insured bonds.

More Downgrades Possible
The risk of further insurer downgrades continues to cast a shadow on the industry. The only major development is that the general quality of the insurers has fallen into three distinct tiers, as shaded in the chart below.

Top Tier — Insurers that are rated AAA/Aaa by all three rating agencies and have stable outlooks.

Middle Tier — Insurers that have tried to retain their AAA/Aaa ratings by adding substantial amounts of capital. While they remain Aaa-rated by Moody’s, they have been downgraded to AA by S&P and Fitch and either have a negative outlook or are on review for a possible downgrade by all three rating agencies.

Bottom Tier — Insurers that are rated below investment-grade quality by one of the three rating agencies.

Major Bond Insurers: Rating & Outlook
Insurer	S&P	Moody's	Fitch
Assured Guaranty	AAA: Stable Outlook	Aaa: Stable Outlook	AAA: Stable Outlook
FSA	AAA: Stable Outlook	Aaa: Stable Outlook	AAA: Stable Outlook
MBIA	AA: On Review for Possible Downgrade	Aaa: On Review for Possible Downgrade	AA: Negative Outlook
Ambac	AA: On Review for Possible Downgrade	Aaa: On Review for Possible Downgrade	AA: Negative Outlook
CIFC	A+: Negative Outlook	Ba2: On Review for Possible Downgrade or Upgrade	CCC: On Review for Possible Downgrade or Upgrade
FGIC	BB: Negative Outlook	Baa3: On Review for Possible Downgrade	BBB: Negative Outlook
XL Capital	A-: On Review for Possible Downgrade	A3: On Review for Possible Downgrade	BB: Negative Outlook
Source: Fitch, Moody's, S&P, Edward Jones. Information as of 6/5/08.

Fewer New Issues Being Insured
Currently, fewer new issues of municipal bonds are being insured. Those that are insured are backed by either FSA or Assured Guaranty (which are both in the top tier). Issuers are currently receiving little or no benefit in the form of lower rates to use any other bond insurer.

Significant differences have developed among bonds backed by insurers in different tiers. There’s a trade-off between interest rate and credit quality. The interest rate offered by bonds in the top insurance tier is lower than that for bond insurers in the lower tiers. In fact, bonds insured by middle- and bottom-tier bond insurers are typically offered at rates that are not that different from those of the uninsured underlying issuer. This suggests that a significant risk of further downgrades exists.

Credit Rating is Key
In the past, your evaluation of a bond may have centered on whether it was insured. Today your primary consideration should be the credit rating of the underlying bond issuer that is being insured. In this new era for bond insurance, you must approach your buying decisions in a way that takes into account the greater level of risk surrounding bond insurers. Contact your financial advisor today about bonds that are appropriate for your portfolio.

Mario D. De Rose, CFA
Fixed Income Strategist

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