After a surprisingly solid year, the $3.7 trillion muni-bond business is getting another boost: the return of insurance.
For investors, this means more municipal bonds will again come with an added layer of protection. The downside is that yields on those offerings will likely drop.
The amount of insured municipal bonds jumped 60% in the first quarter of 2012 from a year ago, to $3.7 billion, according to the Bond Buyer, a trade publication that tracks sales. Municipal bonds are popular among many investors, particularly retirees drawn to their tax advantages.
Municipal-bond insurance, which guarantees an investor's principal and interest payments, was hugely popular before 2008. Muni issuers commonly bought policies from highly rated insurance companies to help boost the credit ratings of their new offerings -- and lower their payouts to investors.
After insurers suffered massive losses on mortgage bonds, they largely withdrew from the muni-bond market. That attracted yield-hungry investors, who bought up uninsured bonds with higher payouts, experts say. Yields hit 3.4% on 10-year Triple A rated munis last January.
Even after the spike to start the year, only about 5% of bonds issued are insured, compared with 57% in 2005.
Still, experts say recent high-profile defaults from municipalities such as Harrisburg, Penn., and Jefferson County, Ala., are reminding investors of how bond insurance can add some protection at a time when many cities still face financial challenges. Investors "are starting to see that there's value in bond insurance again," says Patrick Early, chief municipal analyst for Wells Fargo Advisors.
More insurers are expected to enter the muni market. Assured Guaranty, currently the only company insuring new muni issues, noted in its recent annual shareholder report that three companies were planning to start insuring the bonds. It declined to name the firms.
Experts say more demand for insurance from institutional investors could eventually help some municipalities get financing by drastically reducing borrowing costs. "But we're still a few steps away from that happening," says Matt Fabian, managing director for Municipal Market Advisors. Already, without a big pickup in insurance, $79 billion in new bonds were floated in the first quarter, up 60% from last year, according to the Bond Buyer, as issuers refinanced existing debt at lower interest rates.
But the return of insurance may have a flip side. Analysts caution that if a major jump in muni-bond insurance draws more investors to the market at a faster pace than cities can issue new bonds, bond yields could shrink. Indeed, over the past year, the average yield on Triple-A rated muni bonds has fallen to 1.9%, from 2.9%, according to MMA.
Experts say there's another wrinkle. Assured Guaranty survived the downturn by avoiding riskier bonds, but now the company is under review by Moody's (MCO)
"We're still kind of in a rough patch," says Jim Ryan, an analyst with Morningstar. "There are still a number of municipalities with quite a few problems."
All the more reason for investors to seek out insured bonds, says Richard Ciccarone, managing director at McDonnell Investment Management. Municipalities pay for insurance, which typically costs up to 1% of a bond sale, in order to issue bonds with lower yields -- about 0.2 percentage points less than uninsured bonds, according to MMA. In return, investors get more peace of mind. "Insurance is the icing on the cake," says Mr. Ciccarone.