Municipal bond insurers cannot rely on rising interest rates as a panacea for the recent slowdown in earnings growth, Standard & Poor's Corp. said in Monday's issue of CreditWeek Municipal.

"In the long run, a cyclical upswing in interest rates can have a beneficial impact on bond insurers' earnings and returns," Standard & Poor's said in the report, "Bond Insurers' Cyclical Woes." "But a return to the extraordinary returns on capital experienced in 1993 is not likely."

Some insurance executives say that 1992 and 1993 were anomalies, and that the more than 20% earnings they enjoyed those years cannot be the industry standard. But others argue that "all this industry needs is an upturn in interest rates and all the problems with premium pricing would go away," according to Richard P. Smith, managing director at Standard & Poor's and author of the report.

"Higher interest rates will help [but] rates going up doesn't solve all the problems of the industry in terms of returns," Smith said.

The bond insurers are facing short-term setbacks due to the upward swing in interest rates, which are significantly slowing the pace of earnings growth. In particular, higher rates have ended the refunding boom that propelled the insurers' earnings to dazzling heights in 1992 and 1993.

More troubling, premium rates are on the decline, according to several sources, thanks to increased competition among the insurers and a slowdown in overall volume.

But the Standard & Poor's report contends that bond insurers can expect a long-term boost from several factors related to rising rates:

* The building of an "inventory" of higher-coupon securities that will be refunding candidates during the next downturn in rates.

* Higher premiums thanks to higher total debt service on insured issues and wider yield spreads.

* The opportunity to invest in a higher yield environment.

Smith said that while those factors are "related to the practical dynamics of the business" and very likely to occur, "simply sitting back and waiting for the cycle to turn may be a prescription for mediocrity at best. At worst, it could be an issue of survivability."

Bond insurers aiming for long-term success must seek greater profit margins by focusing on less competitive businesses, expense controls, and more prudent use of capital, the report said.

"On balance, returns may improve but they won't get back to wonderful levels" by themselves, Smith said. "You can't sit there and let the cycle drag you along."

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