As Berkshire Hathaway quietly moves into the business of municipal bond insurance, rivals and bond issuers question the outcome
For Warren Buffett, timing is everything. And with credit markets tightening, prices likely to rise, and longstanding competitors on the ropes, it may be the perfect time for the überinvestor to move into the business of offering bond insurance for cities, states, and government bodies. Buffett, who has long been a big player in insurance with such companies as Geico, sees opportunity in the industry's tumult, longtime colleague Ajit Jain told BusinessWeek on Dec. 28.
"Our hypothesis is that the pricing is going to firm up going forward and we will reach a level we will find attractive," says Jain, who heads Buffett's reinsurance business in Stamford, Conn. "If that were to happen—and I hope it will happen—then we are in a state of readiness and we'd start writing municipal bond insurance."
Buffett's Berkshire Hathaway Assurance (BRKB) is moving gingerly but deliberately into the business and will give longstanding players a run for their money. The company is expected to gain a license from New York state insurance authorities by Dec. 31 and, says Jain, will soon afterward seek approval to operate in California, Puerto Rico, Illinois, Texas, Florida, and Massachusetts. "There's no formal plan," he says. "It's one step at a time."
Big players in the business, such as MBIA (MBI) and Ambac Financial Group (ABK), have been struggling amid anxieties about potential defaults on bonds and other debts they guarantee are supported by subprime mortgages. As a major part of their business, such outfits guarantee the bonds issued by government entities to finance public works such as schools and sewer systems. Even though their risks for government-bond defaults are small, their exposures in other areas are worrying investors and rating agencies and forcing them to seek hefty dollops of capital to preserve their high ratings.
Buffett's entry as a rival in the business isn't helping them either. MBIA's stock had dropped some 16% on Dec. 28, to close under $19, having plunged from about $76 per share early this year. Likewise, Ambac shed nearly 14%, to about $25, after sliding from above $96 early in the year. Such companies are scrambling to find private equity investors or other companies that can provide more than $1 billion each in capital to keep the insurers afloat.
Buffett expects that the bond guarantors will have to charge higher fees after years of pricing their policies too low. "We historically didn't think the pricing in the business didn't reflect an adequate return for risk-bearers," says Jain. "People were not realistic about the loss potential in this business."
Even though Buffett's outfit is planning to price its guarantees above the others, the total cost to the municipalities and other bond issuers could wind up lower with his company. Experts in the field say the issuers could save slightly on the terms they offer investors because investors will feel more comfortable with the bonds with an entity as financially strong as Berkshire Hathaway behind them. "Even if you pay a little higher of a fee, you're better off on a net basis," says John Miller, who heads the municipal investment team at Nuveen Investments, a Chicago firm specializing in municipal bonds.
Betting on Buffett
The gamble for Buffett, however, is that bond issuers may see little reason to seek guarantees on their bonds. Because of the distress the guarantee firms are now suffering, investors are fixing virtually no additional value on guaranteed bonds compared with those without such backing. "They're trading at or near where they would if they were just independently priced, without the insurance," says Miller.
However, industry observers believe that a special "Buffett premium" would make municipalities eager to seek out his company's imprimatur. His move into the business is certain to draw interest from issuers and further unsettle rivals.
"I learned a long time ago: Do not bet against Warren Buffett," says Donald Light, a senior analyst who tracks the insurance industry for Boston-based Celent, a financial advisory firm. Light is a Berkshire Hathaway shareholder.