Nov. 23 (Bloomberg) -- By Joe Mysak
What happens if the insured municipal bond I bought is downgraded, and no longer rated AAA?
The price might drop a little bit. That's about all.
But I bought a AAA-rated bond, not a AA or A-rated bond!
Sorry, you bought an insured bond. The answer is still: Not much happens.
Won't the issuer cancel the policy and go out and try to find a AAA insurer to substitute?
No.
That is so unfair.
That may be. My advice to you is to dig deep into the official statement, or offering document, to the bonds you bought, and start reading.
There's always a section on the bond-insurance policy and what it means, and always a so-called ``specimen'' of the insurance policy appended at the end of the document. They are often pretty dense reading, saturated with legalese, a lot of ``hereins'' and ``whereofs,'' but you can get the gist of it.
And maybe your insurance policy says something about the insurer being downgraded, and maybe you have some options, but I haven't seen any such escape clauses. Municipal bonds are particular and specific to a remarkable degree, but the insurance policies look pretty similar.
Don't Know
The chance of one of the major municipal bond insurers losing its AAA credit rating is now officially a possibility. Fitch, Moody's and Standard & Poor's are all looking at how the insurers' excursions into the world of collateralized debt obligations in recent years inflicted damage to their balance sheets. The rating companies may then tell the insurers they need more capital to retain those ratings, or face downgrade.
The insurers will then have about a month or so to raise that money.
I still think the chance of a major insurer losing its AAA rating is remote. At this stage, though, it looks like nobody knows just how seriously the insurers may be affected.
On Nov. 2, James Fotheringham of Goldman, Sachs & Co. lowered both Ambac Financial Group Inc. and MBIA Inc. from ``buy'' to ``neutral,'' and said, ``We do not know enough about the structure of each insured CDO to forecast potential incremental capital requirements with any confidence; all we know is that further downgrades are expected.''
Fotheringham's was the majority opinion. None of the analysts who are paid to look at these companies seem to have a real grasp of what kind of fix they are in.
Timely Payment
Bond insurance guarantees timely payment of principal and interest on your bonds. If you own bonds that mature in 10 years, you will get your regular debt service payments over 10 years.
I took a look at an Ambac policy the other day, which happened to be appended to the $50 million Las Vegas Convention and Visitors Authority revenue bond issue sold on Nov. 14. This was a somewhat unusual issue in that the authority sold the bonds at auction, and paid for the insurance up front. Usually the underwriter has the option of bidding with or without insurance.
``This Policy is noncancelable,'' it says. ``The premium on this Policy is not refundable for any reason, including payment of the Obligations prior to maturity.'' The policy does not insure ``against any risk other than Nonpayment.''
There was nothing in the specimen policy mentioning a rating downgrade. On page 4, under the section entitled ``Bond Insurance'' was this sentence: ``No assurance can be given by the Authority that the Bond Insurer will be able to meet its obligation under the Policy.''
Your Problem
I can just hear the huffing and puffing: ``What's the value of bond insurance? What are they paying for?''
The answer is: the issuer gets all of its value on Day 1. When the bonds are priced, they are priced on an insured AAA scale, which contains lower interest rates than the borrower could get using its own rating.
I took a look at another insurance policy, this time for the Department of Budget and Finance of the state of Hawaii. The department sold $265 million in revenue bonds on March 1, and they were insured by FGIC Corp.
The actual specimen policy was unremarkable, containing the usual language on timely payment. On page 23 of the offering statement, the issuer included a section on credit ratings: ``These ratings are not recommendations to buy, sell or hold the Bonds, and are subject to revision or withdrawal at any time by the rating agencies. Any downward revision or withdrawal of any of the ratings may have an adverse effect on the market price of the Bonds. Financial Guaranty does not guarantee the market price or investment value of the Bonds nor does it guarantee that the ratings on the Bonds will not be revised or withdrawn.''
What happens if a bond insurer is downgraded? That's your problem.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net
