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Now that Buffett has exited the market, can Ross' Assured Guaranty prosper?
Wilbur Ross has something many business owners might envy: a monopoly in muni bond insurance. The question is, how much money can he make in a shrinking business?
The 72-year-old billionaire is the top individual shareholder in Assured Guaranty (AGO), the only company left in the $2.8 trillion debt market for municipal bond insurance now that Warren Buffett, 80, has stopped his Berkshire Hathaway Assurance (BRK/A) from backing new issues. Buffett said last year that deteriorating state and local finances had made the business "dangerous."
Buffett and Ross were left alone in municipals two years ago after the two industry leaders, MBIA (MBI) and Ambac (ABK), plus Financial Guaranty Insurance, the No. 3 company, were stripped of their AAA credit ratings amid losses from insuring mortgage-backed bonds.
Municipal failures have become a concern in the economic slump that began in December 2007. Forty-six issuers have defaulted on about $1.7 billion of municipal bonds this year, the Distressed Debt Securities newsletter reported in August. Typically, $1 billion of munis fail in a year, it said. Driving defaults is declining tax income. Collections by states in April, May, and June were 17.2 percent less than in the same period two years ago, the Nelson A. Rockefeller Institute of Government said on Aug. 30.
Shares of Assured, in which Ross is the second-largest shareholder after Wellington Management, have tumbled 28 percent this year as of Aug. 31. Berkshire Hathaway B shares have risen 20 percent. The Harrisburg Authority in Pennsylvania, which operates a trash-to-energy incinerator, is the kind of problem that investors are worried about. Assured Guaranty has had to make more than $1 million of missed payments since last year on Authority bonds it insured.
Ross, who declined to comment for this story, remains undeterred. Bermuda-based Assured has backed every state and local bond that carried insurance this year, company filings show. That's about $13 billion of face value in the first half of 2010, according to the documents.
Still, the market for muni bond insurance appears to be declining. At the current pace, Assured's municipal business, including policies acquired when it bought Financial Security Assurance Holdings in 2009, will shrink 45 percent from its 2009 level of $47 billion. Industrywide, the portion of new municipal bonds insured fell to 9 percent last year from 57 percent at its peak in 2005, Standard & Poor's (MHP) said in a June 24 report on Assured Guaranty. "Investors and issuers are learning to live without insurance," S&P's analysis said.
Assured's AAA credit rank from S&P means an issuer buying its insurance takes on that rating, making its securities more attractive to investors and reducing borrowing costs. That's becoming less necessary as investors fleeing declining stock markets pour cash into municipals and U.S. Treasuries, pushing tax-exempt yields to record lows. Also, Moody's (MCO) and Fitch Ratings recalibrated their credit scores this year so the default risk of munis could be compared with that of corporate bonds. The change led to higher grades for many cities and states, lessening their need for insurance.
"Having a monopoly isn't going to do them any good," Gao Liu, who teaches public policy and administration at the University of New Mexico at Albuquerque, says of Assured Guaranty. "They can charge a high premium, but the market is still decreasing."
The bottom line: While Assured Guaranty is the sole active muni bond insurer, profits are threatened by growing default risk and less demand for coverage.