Municipal bond insurance provides protection for investors who purchased municipal bonds, or munis, issued by state, city, and governmental agencies. Bonds are debt instruments sold to raise the capital required to fund various public projects, including infrastructure, schools and housing developments. Many issuers of municipal bonds also use many of the projects they finance to create revenue streams. Issuers buy municipal bond insurance in order to raise the rating on the bonds, thereby making them more attractive to investors.
MGIC Investment Corporation formed the first municipal bond insurance company in the United States in 1971. Up until that time, government bond offerings were rarely insured. In 1975, the near bankruptcy of New York City had many investors on Wall Street concern about the consequences of the city defaulting on its bond payments. When a large Pacific Northwest utility company, Washington Public Power Supply, could not meet their payments on $2 billion US Dollars worth of outstanding bond payments in 1983, the pressure to insured municipal bond began to build. These incidents highlighted the increased vulnerability of investing in municipal bonds.
Internationally, the municipal bond market isn’t has developed as in the United States. Although Canada is the second largest issuer of municipal bonds outside America, municipal bond insurance plays a lesser role since the bonds issued by municipalities are guaranteed by Canada’s Municipal Finance Corporations. Over the past decade, the European municipal bond market has experienced growth. A few of the larger American municipal bond insurance firms have even opened international locations or formed joint ventures to help insure the issues. However, most infrastructure and other public works projects are still primarily funded by banks that specialize in municipal financing.
There are basically two types of bonds issued by government and agencies entities: general obligations bonds and revenue bonds. General obligation bonds are usually repaid from revenues and taxes. Assets are not used to secure general obligation bonds. The principal and interest payments due on revenue bonds are paid from the receipts generate by the project being funded by the bond issue, such as toll bridges and sport stadiums.
Issuers purchase bond insurance in order to raise the credit rating on their municipal bonds offering to triple A. The credit rating of the issuer is not direst factor in rating municipal bonds. The benefit realized by bond insurers is the lower interest rate they generally pay to the bond buyers. Usually, investors will accept a lower yield on their investment capital in exchange for guaranteed payments of interest. Buyers also prefer the safety of their capital offered by municipal bond insurance.
If the bond issuer defaults on the payments, the insurance company that issued the policy will make the interest payments as due. As promised, the principal will be paid at the bond’s maturity date. If municipal bonds are contained within an investment trust, the insurance is good for the life of the bonds or the life of the trust. Municipal bond funds can also carry bond insurance. Typically, municipal bonds must have a BBB rating or higher to qualify for municipal bond insurance.
Insurance companies will only insure entities with a strong investment grade credit rating. Most municipal bond insurance companies have a staff of municipal bond experts, including credit analyst, attorneys, and municipal bond finance professionals. These people are well-trained in every aspect of evaluating the stability and credit worthiness of bond issuers. The areas that are typically usually analyzed include revenues, outlays, and the state of the regional economy. Experts may also consider the tax base, as well as the overall financial strength of the issuer.