Continuing fiscal strain has heightened concerns over the fate of the new municipal monoline bond insurers.
A recent study by the Government Accountability Office (GAO) projects that the operating deficits of US state and local governments will rise to $312 billion in the next two years - $131 billion this year, and $181 billion in 2010. This is a sharp rise from the GAO's November estimate that the total operating deficit would be between $100 billion and $200 billion.
The pressure on municipalities has been reflected in the debt market. Spreads on Markit's 5-year MCDX index, which references 50 municipal credit default swaps (CDSs) were at 204.25 basis points at the close of trading on January 29, making protection on US municipal debt more costly than buying protection on US corporate investment-grade bonds - spreads on the investment-grade CDX.NA were at 197bp as of January 29. Since Markit launched the MCDX last May through early December, the investment-grade CDX.NA saw wider spreads, until recessionary conditions, rising unemployment and the resulting fear of a decline in municipalities' tax revenues, increased the level of perceived risk on these bonds.
This has created uncertainty for newly formed municipal monolines. While Australia's Macquarie Capital Group's Municipal and Infrastructure Assurance was granted a licence by the New York State insurance department in October to guarantee municipal debt, the health of the industry has led some to ask if there is enough business to justify their optimism. Exposures to subprime mortgage-backed securities led to a series of monoline downgrades in 2008, restricting their ability to generate new business. Assured Guaranty, Financial Security Assurance and Berkshire Hathaway are the last bond insurers to maintain AAA ratings with Standard & Poor's, while Assured Guaranty was downgraded to Aa2 by Moody's on November 21.
Dick Smith, managing director at Standard & Poor's in New York, commented: "Assured Guarantee has seen their business decline in the current environment, as has Financial Security Assurance; other insurers are not doing business at all. These new names hope that they will be welcomed into the investment community; if investors have given up on bond insurers or what they require to be comfortable is one of the big unknowns at the moment."
Although the financial crisis has led to concern over the possible default of municipal entities, Smith said that the fears are unfounded: "Municipalities have a strong history of not defaulting under a variety of economic scenarios, including the Great Depression, when there were few defaults. Right now, we are comfortable that these entities are not facing meaningful defaults or payouts."
More on Structured Products
Chris Leone and Dushyant Chadha replace Paul Galietto
Steffen Scheuble says growth in mainstream strategies may be nearing saturation point
Capital-at-risk product pays out early if crude index is no lower than strike price in 30 months’ time
Investors’ capital at risk if underlying is below barrier level at maturity
Sign up for Risk.net email alerts
Sponsored video: MarketAxess
Sponsored video: Tradeweb
Multifonds talks to Custody Risk on being nominated for the Post-Trade Technology Vendor of the Year at the Custody Risk Awards 2014
Sponsored webinar: IBM Risk Analytics
There are no comments submitted yet. Do you have an interesting opinion? Then be the first to post a comment.