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Detroit crisis may give lift to municipal bond insurers

At first glance,it is hard to see Detroit’s bankruptcy filing as anything but another body blow for downtrodden US municipal bond insurers

Written by Reuters | New York | Published: August 12, 2013 12:44:56 am

At first glance,it is hard to see Detroit’s bankruptcy filing as anything but another body blow for downtrodden US municipal bond insurers,which could be on the hook to investors for hundreds of millions of dollars in losses on the city’s debt. But the city’s fiscal upheaval may in fact have the opposite effect — providing the marketing spark needed to revive a business decimated by the financial crisis like few others.

For issuers that have mostly gone without coverage since the 2007-09 financial crisis hammered most bond insurers,Detroit’s filing may serve as a stark reminder of the wisdom of buying insurance. Put simply,insurers’ payment guarantees make their bonds more attractive to investors.

“Investors are going to see the benefit of insurance in action more and more,” said Alan Schankel,head of fixed income research and strategy at Janney Capital Markets. “I think this is net-net a positive marketing story for bond insurance.” Once a familiar fixture,bond insurance gave extra financial security to bondholders,including the retail investors who hold almost half of the $3.7 trillion market,while helping local issuers lower borrowing costs.

Before the crisis,about half of all new municipal bonds had insurance from nine insurers,with nearly 60 per cent covered in 2005. Last year,just 3.6 per cent were insured,and this year the number is just over 3 per cent,Thomson Reuters data shows. Bond insurers collapsed during the financial crisis after they ventured into mortgage-backed securities in the years before 2007. Ratings agencies slashed their AAA ratings to junk or withdrew them altogether. That meant bond issuers no longer benefited from their coverage.

With insurers failing to make promised payments,their stock tanked and so did their businesses. Insurers are among the biggest players in Detroit’s case,as about 86 per cent of the city’s $8 billion debt is insured by six companies. But the bulk of losses is expected on only about $530 million of unsecured general obligation bonds,which are payable over the next 22 years.

That makes the hit insurers would take from Detroit manageable,analysts say. At the same time,coming after other municipals bankruptcies such as Jefferson County in Alabama or Stockton and San Bernardino in California,Detroit would help investors see the benefit of bond insurance.

In June,Detroit defaulted on $1.45 billion of bonds issued to fund its pension obligations. Syncora,which insured most of those obligations,covered $24.7 million. But Financial Guaranty Insurance,on the other hand,which is undergoing a court-ordered rehabilitation process,failed to pay about $16.2 million.

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