One Small Step for a Beaten-Up Insurer and a Battered Muni Market

Author: John Mousseau, Post Date: September 2, 2008
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John Mousseau is a portfolio manager and heads the tax-free Muni section of Cumberland.  He is a member of the Management Committee of Cumberland Advisors.  His bio is found at www.cumber.com.  His email is John.Mousseau@cumber.com

This past week, Financial Guaranty Insurance Corporation (FGIC) announced that Municipal Bond Insurance Corporation (MBIA) would reinsure $184 billion of FGIC’s municipal bond book of insured bonds. We think this is a positive development for FGIC and the bond market.

This means that MBIA – in return for insuring FGIC’s bonds – will receive, over time, $741 million in unearned premium income from the FGIC insured bonds.  In addition, FGIC has paid $200 million to a French bank, Calyon, to commute its exposure to Collateralized Debt Obligations (CDOs)

There are three results from this which should be positive for the beaten-up municipal bond market in general, MBIA overall and FGIC-backed bonds in particular.  First and foremost, this will free up capital for FGIC.  This is important for the ongoing business of FGIC – even if it is in a runoff position.

The second and more important development is that many FGIC bonds could see upgrades to MBIA’s ratings which are A2 by Moody’s and AA by Standard and Poor’s.  Though these ratings were the result of downgrades from AAA/AAA status earlier in the year, they are a far cry from FGIC’s current ratings which are B1 Moody’s (negative outlook) and BB (CreditWatch negative) by Standard and Poor’s.  It also is a positive for MBIA as this will mean additional income from reinsuring risks that are very small, in our opinion.  It is also a further statement of MBIA’s “raison d’être” in the world of municipal finance.

Most insured bonds have been trading to their underlying ratings with the rating cuts of the various bond insurers.  Prior to FGIC’s current problems, it was Cumberland Advisors’ opinion that FGIC insured municipal bonds to the most stringent credit standards of the AAA bond insurers.  The downgrade of FGIC has left a number of very good underlying credits trading very poorly because of the “FGIC-insured” sign on the front of the bonds.  This should be one step in reversing some of this fall-off.

The next step will be to see whether other, previously AAA insurers, such as XLCA or CIFG, can take similar steps towards freeing up capital.  In any event, we view last week’s developments as overall favorable for the battered Muni bond market.

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