The drive to maintain market share heated up among the bond insurers in the first half of 1994, creating a premium competition that may have negative effects in the long run, industry sources say.
Prices for bond insurance in the first six months of the year dropped by about 12% overall from 1993 levels. In some sectors, such as general obligation and utility bonds, insurance rates dropped by 16% to 17%, according to Fitch Investors Service.
In the second quarter, the overall premium rate dropped 16%, with a 23% drop in general obligation rates, a 27% decrease on rates for lease-backed and other tax-backed bonds, and a 25% drop in transportation bonds, according to Fitch, which last week issued a preview of an upcoming report on bond insurance premiums.
In one example from a source who requested anonymity, $18 million of Houston County, Ga., school district lease certificates of participation were insured by Municipal Bond Investors Assurance Corp. for a premium of 22 basis points.
Louisiana State University was able to obtain insurance from Financial Guaranty Investors Co. on a $27 million issuance of college revenue bonds for 28 basis points, another source said, calling it a "low bid for a gross revenue pledge, a less desirable issue."
In another deal, $14.1 million of North Hempstead, N.Y., general obligation bonds were insured by AMBAC Indemnity Corp. for 19 basis points.
One bond insurance official, speaking anonymously, said the premium last year on a deal with similar underlying ratings to the Louisiana State offering would have been about 40 basis points. And last year, bond insurance would have cost North Hempstead from 26 to 28 basis points for the same issue, he said.
"Up until a year ago, you never saw MBIA or AMBAC bid below 25 basis points for anything," the source said. "This year, MBIA started to bid low and AMBAC followed suit hastily.
David Litvack, senior vice president at Fitch, said, "Bond insurers are at a point in their life cycle where they're generating large amounts of earnings and must utilize the capital."
Most of the competition is being blamed on the bond insurers vying for market share, according to industry sources. With the rise of public ownership in the industry in recent years, there is a growing sense among the insurers that they must maintain market share to please their stockholders.
"It's become embedded [in the industry] that market share is what drives it," said Michael Djordjevich, president and chief executive officer of Capital Guaranty Insurance Co.
"Market share at prices that are not sustainable in the long mn doesn't make much sense," said Roger Taylor, managing director and chief operating officer of Financial Security Assurance Co.
FGIC, the only major bond insurer without any public ownership, expressed concern about premium pricing by its chief executive officer and chairwoman, Ann C. Stem, in its quarterly earnings release.
"A ... significant issue for our industry is the severe price competition that has escalated this quarter as a result of a shrinking market," Stern said in the release.
Standard & Poor's Corp. has also been concerned that the recent pricing is insufficient for a decent long-term return, according to Richard Smith, director of the insurance group at the rating agency.
"Today's pricing doesn't leave much of a margin for error," Smith said.
But the largest insurer, MBIA, does not see a price war taking place. Rather, the current environment is simply a reflection of the usual course of business taking place, according to Robert Godfrey, executive vice president at MBIA.
"This is always a competitive business and probably always will be," Godfrey said. Bond insurers deal with state and local officials, who are looking for the best prices, he said.
"It means we've all got to compete to insure the business that we insure," Godfrey said. "Every businessperson in the world would love to sell their product at higher prices. We don't see what all the flak is about.
"Our prices are only slightly off the last two years' peak levels on a competitive basis," Godfrey said. "It fluctuates. For what we're selling, we're reasonably pricing. I can show them the hard statistical data that it goes up and down."
However, as the overall municipal market shrinks and more issues are being sold competitively, the bond insurers are fighting for a smaller number of deals.
In addition, both Capital Guaranty and FSA emerged from lengthy corporate restructurings in the last year eager to battle the industry's larger players. Faced with increased competition in a shrinking market, some of the players have apparently decided that "any kind of premium to go with investment income is preferable to investment income alone," according to one industry source.
Another industry analyst said that some of the insurers are "in between a rock and a hard place." They must decide whether to lower the premiums to a more competitive level or risk losing market share.
For the first half of 1994, MBIA took 39.7% of the market, while AMBAC took 26.9%, FGIC took 23.7%, FSA had 5%, and Capital Guaranty had 2.5%, according to data from Securities Data Co.
"MBIA is being aggressive in its pricing because it's a big engine that requires fuel," a source said.
"We're at the same levels we've always been," MBIA's Godfrey countered. "The spots haven't been turned around so much."
The competition is driven by two forces, say market observers: large insurers striving to obtain larger market shares and smaller insurers such as FSA and Capital Guaranty trying to build market share.
San Francisco-based Capital Guaranty, particularly, has been offering credit enhancement at very low rates, some sources claim.
One industry insider said that the firm bid 12 basis points on a recent $31 million issue by a school district in Minnesota, while bids from the rest of the industry ranged from 22 to 28 basis points.
But "smaller bond insurers do not have enough of a market presence to significantly impact overall premium rates," according to Fitch's preview of its upcoming report. Officials of the smaller firms adamantly deny that they have led the industry into a price war.
"Capital Guaranty hasn't initiated anything in those terms -- it's counterproductive in the long ran," said Djordjevich. "We are like a little shell on the big ocean wave, just going along."
FSA's Taylor concurred: "It's not a path we'll follow," he said, adding that vying for market share is the only reason to lower premiums.
"If you're a player that wrote a tremendous amount of insurance last year, one way to get your position not to go down is to price more aggressively, to take a larger share," Taylor said.
The implications of the current pricing environment on the bond insurers' bottom line and ratings cannot be immediately measured, however, because the lower premium prices will take years to have any real effect, rating agency analysts said.
"It's like eating a bad meal and having to digest it over 20 years," Litvack of Fitch said. The lower premiums in the portfolios remain fixed, bringing in a lower return and increasing risk levels.
Insurers pricing very competitively "can get by without the return showing itself, but it's like having financial termites inside the balance sheet," Djordjevich said.
Historically, premium rates have only gone in one direction -- down -- except for a slight increase in 1993, according to Fitch. However, other market observers say that while the rates are declining, there is the chance that premiums could go back up to 1992 levels.
"We believe that there's a natural floor to premiums," said Ralph Aurora, analyst at Duff & Phelps Credit Rating Co.
The aggressive pricing competition may cease if and when the municipal market picks up again, creating more business and casing competition, according to Fitch and other market analysts.
Ironically, another factor that could halt the trend of declining premiums may be when shareholders start to take' notice and threaten to sell off their holdings, according to Fitch.
"We think it is possible that once the decline becomes apparent, equity holders may pressure bond insurers to raise the premium rates," Litvack said
