Bond insurers are reporting record earnings as they venture beyond guaranteeing municipal bonds and into the exotic world of asset-backed securities.
This obscure but influential business, led by such firms as MBIA Insurance Corp., Financial Security Assurance Inc., and AMBAC Indemnity Corp., enjoyed an 18% rise in net income last year, to an unprecedented $901 million, according to a report issued this week by Fitch Investors Service. This rise accompanies a 7% decrease in premiums received from insuring municipal bonds, Fitch said.
As securitization becomes a game that companies all over the world are learning to play, analysts think the future is bright for bond insurers, assuming they don't compromise their underwriting standards as they vie for market share.
The value of insuring asset-backed securities was vividly demonstrated this February when subprime auto lender Jayhawk Acceptance Corp. filed for bankruptcy.
Jayhawk funded its operations in part by selling securities backed by payments on car loans made to customers with bad credit. But the buyer of these securities, SunAmerica Corporate Finance, was not in danger of losing any of its investment because MBIA had guaranteed their payment.
Analysts and investors value the insurance for the peace of mind it offers. Bond insurers are graded triple-A by the ratings agencies, and when they insure a securitization their rating is conferred on the deal, regardless of the issuer's own rating.
This crucial factor empowers below-investment grade companies to sell highly rated securities and is the engine driving asset-backed securities.
"I sometimes get calls from investors worried about their securities and I ask them, 'Are you worried about the insurer?"' said Jeffrey P. Salmon, head of ABS research at UBS Securities. "Because if they're not worried about the insurer, there's nothing to be concerned about."
Roger K. Taylor, chief operating officer at FSA, which insures the vast majority of subprime auto securitizations, says his company has raised prices for insuring such deals, but has not experienced any losses in the subprime auto breakdown.
Bond insurers make their money by taking a portion of the spread off the securitization. The riskier the deal, the higher the spread. Mr. Taylor said insurers won't guarantee a deal rated lower than investment grade.
Still, even when dealing with investment-grade bonds, it's vital to get new loans on the books to replace older portfolios, which tend not to perform well.
"Bond insurers live off the early successes of their deals," said James X. Callahan, executive director at the Pentalpha Group, a consultancy, and former bond trader at Prudential Securities. "When balances are high, they are paid more, so they' are constantly looking for new product to cover up any problems they might have."
But industry veterans maintain that the business of insuring risks the market is reluctant to assume on its own is more straightforward. "You write policies so they are never called. If they are, you're out of a job," said Mr. Salmon, who says he left Financial Guaranty Insurance Co. on his own.
Such conservative policy-writing helped bond insurers cut their losses by 44% in 1996.
Bond insurers were also helped last year by the fact that most credit card issuers don't insure their securitizations. As a result, when companies like Banc One Corp. and Advanta Corp. ran into rising chargeoff problems recently, the bond insurers avoided that flare-up.