With another record year for bond insurers coming to a close, industry executives and rating agency analysts are looking ahead to 1994 with guarded optimism.
The consensus is that next year's insured municipal bond volume will not approach this year's level. The volume of refunding issues, which is expected to account for as much as 60% of all insured bonds in 1993, should decline notably, so the overall amount of insured bonds should also drop.
Robert J. Genader, senior executive vice president at AMBAC Indemnity Corp., said lower volume is but one factor in trying to gauge how 1994 will play out for the industry. Rate sensitivity will also be important, he said.
"I'm seeing that municipal issuance is very sensitive to rates," Genader said. "In November, we approved a lot of deals that sat. Then two small windows opened up and most of the issuance was done. I see that pattern continuing."
But the prospects are anything but bleak for the bond insurers. The five primary firms enhanced about 40% of total issuance this year, and their market penetration is expected to remain in the 35% to 40% range in 1994. A recent report from Roosevelt & Cross Inc. predicts that as much as 50% of new bonds issued next year will be enhanced because insured bonds continue to trade cheaply when compared with long-term Treasury bonds.
Robert R. Godfrey, executive vice president at Municipal Bond Investors Assurance Corp., agreed that 1994 volume will be off from 1993's record, but said that will be offset by "flaming, almost voracious" buying of tax-exempt bonds by retail buyers, life and property/casualty insurance companies, and profitable banks.
In general, bond insurance executives and rating agency analysts predict two major trends for the industry next year: increased competition and greater diversification into new services and products.
"Now that the refunding feast is winding down, the challenge will be to compete well in leaner times," said David Litvak, vice president at Fitch Investors Service. "The bond insurers who do well are the ones who can keep expense ratios down and maintain pricing discipline in the face of increased premium rate pressures, [as well as] successfully introduce new products."
Competition among bond insurers has been intense in 1993, but the overwhelming volume of insurable bonds, particularly refunding issues, offset the effects of occasional price slashing.
With a revitalized Capital Guaranty Insurance Co. and an expected resolution to Financial Security Assurance Inc.'s ownership structure, the playing field in the municipal bond insurance industry will be more crowded than ever in 1994. Combined with an expected drop in volume and the pressure on the publicly owned insurers to maintain returns on equity, some industry observers fear a price war is looming.
"Pricing pressure will continue next year," said Richard P. Smith, managing director at Standard & Poor's Corp. "There is the thinking that if volume is down for the first time with so many public companies, maybe they'll react aggressively to keep volume up."
But not all are convinced that price gouging will necessarily occur.
Ann C. Stern, president and chief executive officer of Financial Guaranty Insurance Co., said the increased level of public ownership in the industry might just as likely discourage price cutting.
"Normally, public companies have to be concerned about return on equity. I'm hopeful that will be a countervailing force," Stern said. "Because they have to show investors a good rate of return, they will try harder to compete on the basis of service and will be less [tempted] to embark upon a price war."
The FGIC executive said she was unable to predict on what basis competition will evolve in the coming year, adding that she is hopeful it will be in client services instead of premium pricing, "where [FGIC's] appetite for significant competition is not great."
MBIA's Godfrey said an improvement in the trading value of insured bonds will open up new rating categories. He noted that there is still room for the insurers to grow in traditional markets.
"I see continued increased penetration by the industry. We haven't completely covered all of the good bonds in the market," Godfrey said. "That will help mitigate against severe price competition."
Another executive from one of the Big Three firms, speaking anonymously, said he did not think the revitalized Capital Guaranty or FSA would engage in price cutting, because of the trading differentials and because it would be counterproductive.
"They can undercut us, but then their return on equity goes down," he said. "They can win deals by grossly undercutting, but my advice is for them to stake out niches where they can excel and don't try and go head-to-head on insuring a [general obligation] bond with AMBAC, FGIC, or MBIA."
Stern of FGIC said the search for greater return on equity will continue to lead the industry into new directions. Because of the market's efficiency and maturity, rates of return for bond insurers in the municipal market have declined, she said. As a result, the monoline insurers have sought to leverage their expertise in new products and services, where returns are presumably higher.
The overwhelming consensus among industry observers and participants is that the trend will continue in 1994.
"We anticipate an expansion in services already offered as well as an expansion into new services," said Lara Levenstein, vice president and assistant director at Moody's Investors Service. "From our perspective, the biggest issue for 1994 is how diversification and different types of risk impact the capital adequacy of the insurers. It's something we're watching very closely."
Diversification keeps the industry from becoming stagnant or being viewed as one-dimensional, which keeps rates of return attractive and fosters the flow of capital to the firms, Stern said. The first wave of diversification has been a leveraging of the insurer's relationships with municipalities, she said, predicting the next phase will be a leveraging of knowledge.
The insurers' data bases are "the biggest assets the companies have," Stern said, and she expects all the firms to seek a way to market the information.
But not every firm is ready to join the expansion parade.
Michael Djordjevich, president and chief executive officer of Capital Guaranty Insurance Co., said expansion for the larger firms is "understandable," but that it does not make sense for Capital Guaranty.
"We are not at that stage of development, but it's good we are in the situation as the market may become tougher, which demands more control," Djordjevich said. "If you have to make sharp turns, it's better to be a destroyer than an aircraft carrier. We want to remain quick and nimble because the future is uncertain."
The Capital Guaranty executive said that lower volume next year might signal the beginning of a trend toward "belt tightening" in the industry, as the bond insurers are forced to control their expenses.
Expansion is generally considered a positive step for the bond insurers, providing diversified earning and boosting the return on equity, but rating agency officials are wary of the insurers getting lost in the excitement of new products.
Smith of Standard & Poor's said the insurers will face "tension" in the coming years to maintain the balance between the desire for new growth and their "pristine" claims-paying ability ratings.
"It's not necessarily a 1994 story, but the trend is that those tensions will grow," he said. "We expect to be having more internal discussions about how to manage those tensions. It may reach the point where something might give."
Smith said this month's downgrade of Capital Re Corp.'s corporate debt in conjunction with an announced diversification is an example, although he noted that the firm's AAA rating for claims-paying ability was affirmed.
"Tension first hits the debt rating, but ultimately if it gets bad enough it could jeopardize the claims-paying ability rating if a company always opts for growth to the detriment of the claims-paying ability," he said.
Other issues on the insurer's docket next year include the continued use of insurance in the structured finance and European markets, and potential competition from pension funds and government-sponsored entities.
This year, Standard & Poor's announced its criteria for rating pension funds, which Smith said could clear the way for pension funds to insure local bond issues,
"It's a potential source of competition," he said. "There have been a lot of rumors about pension funds wanting to get into this business. A rating might be one less hurdle."
On other fronts, Djordjevich said the industry will make a more consolidated effort to deal with federal regulatory issues in the coming year. He also said the industry needs to take a look at how bond insurance is distributed and how the industry is going to continue to foster demand for its products.
Smith sees two new opportunities for the industry. First is the potential for a "creative reinsurance solution" to the problems of high volume issuers that are often unable to obtain bond insurance because of "name capacity problems," he said.
Secondly, there is a shortage of high quality short-term paper in the market. Both FGIC, which provides liquidity to variable-rate debt through its Securities Purchase Inc. affiliate, and MBIA, which creates synthetic short-term tender option bonds through its Topstar program, have attempted to tap this market.
However, "those two haven't solved the problem," Smith said. "A lot of people see demand [and] it's a big enough issue that [the insurers] could try and solve it."
