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A "Marketbeater" Strategy

Tuesday, Apr 04, 2017

ADD DISTRESSED INSURED MUNICIPAL BONDS TO YOUR FIXED INCOME PORTFOLIO

Investing In Distressed Issuers Whose Bonds Are Insured By S&P “AA” Rated Quality Bond Insurers Is A “Marketbeater” Strategy.

Safety:

Guaranteed timely payment of interest and principal.  Informed investors find comfort and value in the three major insurers; Assured Guaranty, S&P “AA”, Moody’s “A3”, National Public Finance Guarantee, S&P “AA‐ ”Moody’s “A3”, Build America Mutual, S&P “AA, ”Moody’s “NR”.

Yield:

In general insured municipal bonds often yield more than similar rated uninsured bonds. The vast majority of issuers that qualify for insurance have investment grade ratings. For this reason default claim payments are historically minimal for major insurers, approximately 0.05% of bonds insured. There are currently numerous unique insured bond opportu‐nities that exist in today’s muni market. When a previously investment grade bond that was insured by a “AA” rated insurer becomes a speculative security the insured bond rating still remains “AA”. The original investor has the com‐fort their now speculative rated bonds are insured, informed aggressive investors recognize value and pursue depressed bonds that carry quality insurance.  

Liquidity:

Insured muni bonds have historically offered as much or more secondary market liquidity as other municipal bonds.  The safety and unconditional guarantee insured bonds offer make them approved investments for most retail accounts, fiduciary trusts, institutional accounts and municipal bond funds, therefore their liquidity is enhanced. Informed investors realize that top bond insurers provide several layers of protection throughout the life of the bond.

Safety Net Protection:

Financial guaranty and expert interme‐diation with distressed issuers.
The value of insurance is most visible with municipal bond Fallen Angels, insured bonds that were investment grade when initially insured and whose non‐insured bonds are now speculative grade bonds. Quality bond insurance provides added value to these speculative grade bonds. Signiicant claims paying resources of quality bond insurers minimize debt service shortfall risk that speculative bonds carry. Insurers' liquidity for claim payments due over the life of the bond comes from earnings based on strong, stable premium reserves, investment portfolio income and statutory capital.  

Insured bondholders rely on insurance while insurers fight the battle with distressed obligors.  Insurers bring to the table distinct workout teams including legal counsel to lead creditor committees.  

At present low interest rates, new insurance is written on about 5% of new municipal bonds issued. Amid a supply drought of insured municipal bonds, the low volumes of new insured issues and maturing insured bonds enhance the value on outstanding insured municipal bonds.

There is a strong demand for insured bonds. Insurance volume is expected to rise gradually as issuance grows.  Assured Guaranty is expected to keep its lead due to consolidated market share.  Well capi‐talized National should eventually bring price competition.  New bond insurer Build America Mutual, (BAM) established in 2013, rated S&P “AA”, is a quality insur‐er widely accepted by issuers and inves‐tors.  The GMS Group website has a report on all insurers including  the other notable insurers AMBAC and Radian.

Assured Guaranty (Ratings: Moody’s “A3” S&P “AA”) NYSE: AGO... 2016 was very successful as Assured Guaranty continued to build on its market leadership. AGO insured about 56% of bonds insured in 2016 or $14 bil‐lion. AGO nearly doubled insured volumes in its secondary market business by insuring $16 billion bonds. AGO’s competitive edge is its ability to insure signiicantly large municipal transactions due to the scale of its capital. Acquisitions, combined with natural amortization of AGO’s insured portfolio, boosted excess capital and claims paying resources relative to insured par value. AGO continued to generate excess capital of more than $2.6 billion above the “AAA” requirement under S&P’s capital adequacy model. Its “capital leverage” or ratio of insured net par value outstanding $296 billion “A” internal rating to claims paying resources $11.7 billion declined to 25:1 in 2016 down from 27:1 in 2015 and 51:1 in 2009. In July 2016 AGO acquired CIFG NA and in January 2017, MBIA U.K. as part of its growth strategy. AGO is needed for Puerto Rico’s future capital market access. It engaged with lawmakers for the enactment of Puerto Rico rescue law PROMESA. S&P, Moody's and KBRA have stated that AGO has the resources to manage potential losses under even severely stressed Puerto Rico scenarios and retain its current ratings. Its $11.1 billion investment portfolio “A+” average rating generates roughly $400 million of annual investment income alone, higher than the average annual net debt service for the next 10 years on AGO’s Puerto Rico exposures. AGO has fully protected insured bondholders by paying $226 million in claim payments to date. AGO continues to defend constitutional, statutory and contractual rights of insured Puerto Rico bondholders.

National Public Finance Guaranty (Ratings: Moody’s “A3” S&P “AA-”) “National”... National’s excess capital position continues to increase as its statutory capital has grown and its operating leverage dropped. National esti‐mates its excess capital relative to S&P’s “AAA” stress tested capital requirements is $1.7 billion. National is the largest “municipal only” bond insurer, as measured by insured par. National’s $4.6 billion of claims paying resources insure $110 billion gross par value outstanding: its 2016 capital leverage or ratio of gross par outstanding to claims paying resources is 24:1 down from 60:1 in 2012. National has a $4.2 billion investment portfolio. National, a subsidiary of MBIA, could pay a special dividend to MBIA subject to regulatory approvals. National advocates PREPA restructuring support agreement provides a workable framework for resolving PREPA's credit proô€€€ile in a way that's well balanced and fair to all parties and is consistent with the strategic imperative put forth by the Governor to negotiate consensual deals with creditors and the Governor's energy reform agenda. National has made strong progress after its 2015 re-entry to insuring new municipal bonds. In 2016 National insured $1.6 billion of par value, almost triple the $597 million its 2015 insurance volume. Rated by S&P at one notch below its two main competitors AGO and BAM, National is trying to achieve credit ratings parity. National's capital adequacy and liquidity positions remain extremely strong, anchored by National's $4.2 billion investment portfolio which is primarily comprised of highly rated marketable securities.

AMBAC “NYSE: AMBC”... A low leverage ratio of 11:1 as $8.8 billion claims paying resources insure $79 billion net par insured. AMBC has a $6.5 billion investment portfolio. Strong income for the full year offset a fourth quarter loss mainly due to Residential Backed Mortgage Securities (RMBS), student loan exposure and higher reserves on Puerto Rico exposure. AMBC negotiated a $995 million cash settlement with JPMorgan on its RMBS litigation, opportunistically purchased $659 million of Ambac in‐sured securities in 2016 and brought in a new CEO. AM‐BAC has mounted a robust defense of the COFINA bond structure challenged by general obligation bondholders. COFINA bonds have been fully paid from strong pledged sales tax collections while general obligation bond pay‐ments were missed by the former Governor. AMBC has paid all claims aggregating to $63 million on its $2 billion gross par value Puerto Rico exposure comprising general obligation, COFINA, Highway, Rum Tax and Convention Center bonds. AMBC views the Rossello administration as a positive development, it supports PROMESA’s litigation stay and is pursuing consensus. The continued run‐off of AMBC’s insured portfolio, down 27% from a year ago, has boosted its claims paying resources for its outstanding exposure as it is not writing new insurance.

Build America Mutual (Rating: S&P “AA”) “BAM”… Claims paying resources increased to $643.7 million or 7% more than a year ago. Gross par value outstanding rose to $33.1 billion, up 46% from a year ago. Its $14.7 million fourth quarter increase in claims‐paying resources is the largest quarterly increase since the company was founded in 2012. BAM’s capital leverage or ratio of gross par outstanding to claims paying resources is 53:1. A “municipal only” bond insurer, BAM has no below investment grade insured exposure.

Ready to learn more about high-yield bonds? Let the bond specialists at GMS Group help you make the best investments so that you can meet your financial objectives! Contact us today for assistance or call 877-467-0070.