Muni Bond Insurance is Making a Comeback and it May be Worth the Price

The COVID-19 pandemic has put a significant strain on municipal bonds. While general obligation bonds continue to be safe, revenue bonds backed by universities, senior housing, and convention centers are in jeopardy. Fortunately, the resurgence of bond insurance has provided many investors with peace of mind as the crisis unfolds.

Let’s take a look at the history of muni bond insurance and how it’s making a comeback in the midst of the COVID-19 pandemic.

Bond Insurance: A Brief History

Muni bond insurance ensures that principal and interest are paid in the event of a default. Furthermore, bond insurance is a type of “credit enhancement” that assists issuers in lowering borrowing costs.

By guaranteeing the bonds, insurers effectively lend their high credit rating to issuers, making them less risky for investors.

While bond insurance was common prior to 2007, exposure to mortgage-backed securities and structured finance hurt MBIA, Ambac, and other large insurers. Rating agencies promptly reduced their credit ratings in response to their failure to compensate insured bondholders, resulting in less than 5% of bonds being insured.

The city of Detroit then defaulted on $18.5 billion in municipal debt in 2014. Bond insurers redeemed themselves during the crisis by making sure that insured bondholders were compensated. In 2015, Puerto Rico defaulted on its debt, and bond insurers once again made sure that insured bondholders were compensated. These occurrences aided in restoring investor confidence in bond insurance.

Why Is Bond Insurance Experiencing a Resurgence?

The COVID-19 crisis increased demand for bond insurance even more. Because of the unpredictability of lockdowns, many investors sought insurance to protect themselves from default risks. Bond insurance has been especially useful for revenue bonds backed by COVID-19-affected assets like convention centers or amusement parks.

Active investors may benefit from bond insurance as well. During the height of the crisis, the spread between insured bonds and 10-year Treasuries increased from 20 to 190 basis points. They have since fallen from their highs, but they remain above pre-crisis levels, implying that yields may fall and prices may rise over time.

Insured munis accounted for roughly 10% of all muni bond issues as of December 2020, with more high-quality issuers offering insurance to reassure investors concerned about rating downgrades and defaults. Furthermore, the insurance costs an average of only 20 basis points, making it an extremely cost-effective way to achieve peace of mind.

Use a tool like BondView’s Muni Bond Screener to quickly find and determine if the bonds that are of interest to you are insured.  

In conclusion

Bond insurance may not be as popular as it was prior to the 2008 financial crisis, but the COVID-19 pandemic is driving up demand for protection. Given the pandemic’s unpredictability and the low cost of insurance, many high-quality issuers are providing insurance to reassure investors and attract capital at the lowest possible rates.