American Municipal Bond Assurance Corporation - Explained
What is the American Municipal Bond Assurance Corporation?
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Table of ContentsWhat is the American Municipal Bond Assurance Corporation?How Does the American Municipal Bond Assurance Corporation Work?Bond InsuranceAcademics Research on American Municipal Bond Assurance Corporation
What is the American Municipal Bond Assurance Corporation?
The American Municipal Bond Assurance Corporation provides insurance against default on municipal bond offerings.
How Does the American Municipal Bond Assurance Corporation Work?
The American Municipal Bond Assurance Corporation (Ambac) started in 1971 as an MGIC Investment Corporation of Milwaukee subsidiary. It was the premier company to provide issuers of municipal bonds with insurance. A municipal bond issuer might buy insurance coverage so as to increase as investor's confidence that principal and interest payments would be made fully and in a timely manner if the issuer defaults. The insurance functions as a bulwark against default in that it reduces the risk and raises the issued bond's credit rating. The more confidence created by the coverage implies that insured bonds are capable of commanding higher prices, paying lower interest rates, and in general benefiting from more liquidity unlike uninsured bonds. Ambac continues to one of the top bond insurers and the insurance market continues thriving, though there was a major decline in following the 2008 financial crisis. Currently, the organization functions under the name Ambac Assurance Corporation and it serves as a key operating unit of Ambac Financial Group, a holding company based in New York.
Bond insurance works similarly to any other insurance policy. Issuers take out insurance against default and premium payments are priced by a bond issuer based on the risk perceived by the issuer. Supposing the issuer doesn't make payments on time during the bond period, it's mandatory that the issuer makes the payments. This dynamic implies that an investor usually considers an insured bond in order to have the exact credit rating the firm ensuring the bond has, irrespective of the underlying securities' credit rating. From an investor's angle, the only default risk arises from the possibility that the bond insurer doesn't pay. In general, bond issuers only cover securities whose underlying ratings depend on the investment-grade territory, or no lower than BBB. While it's mandatory that bond issuers pay insurance premiums, the improved debt's creditworthiness can generate huge benefits by improving the loan's terns, mainly by reducing yields or expanding the access an issuer has to debt markets. To the point that the improved terms of the loan lessen the cost of borrowing greater than the increased cost created by insurance premiums, the issuer of the bonfire comes out ahead. Practically, investors also end up paying for insurance premiums to the point that they take reduced returns on debt which will expose them to greater risk, and thus yield higher returns, supposing it was uninsured.
Academics Research on American Municipal Bond Assurance Corporation
- Estimating the signaling benefits of debtinsurance: The case ofmunicipal bonds, Kidwell, D. S., Sorensen, E. H., & Wachowicz, J. M. (1987). Estimating the signaling benefits of debt insurance: The case of municipal bonds.Journal of Financial and Quantitative Analysis,22(3), 299-313. This paper examines the demand for municipal bond insurance in the context of a competitive signaling equilibrium model. The study compares the pricing of new bond issues that are insured to similar issues that are not insured. The results indicate that issuers who purchase bond insurance, on average, are able to reduce their new issue borrowing cost more than enough to offset the cost of the insurance premium. Furthermore, the net benefit to the issuer increases as the underlying credit quality of the bond declines.
- The interest cost effect of private municipal bond insurance, Cole, C. W., & Officer, D. T. (1981). The interest cost effect of private municipal bond insurance.Journal of Risk and Insurance, 435-449. This paper examines the impact of private municipal bond insurance on the interest costs of local government bonds. Based on the examination of True Interest Costs of both guaranteed and non-guaranteed municipal bonds over a three year period, results indicate that, on average, the interest costs of guaranteed bonds are significantly less than costs estimated for bonds without such protection. Investors in insured municipal bonds seem to demand a greater risk premium for the insurance coverage as the underlying credit rating of the issue rises. [CITATION]
- The effect of private municipal bond insurance on the cost to the issuer, Braswell, R. C., Nosari, E. J., & Browning, M. A. (1982). The effect of private municipal bond insurance on the cost to the issuer.Financial Review,17(4), 240-251.
- Municipal Bond Insurance: Past, Present, and Future., Cohen, N. R. (2013). Municipal Bond Insurance: Past, Present, and Future.Municipal Finance Journal. From the first municipal bond insurance policy in 1971, bond insurance grew to about 54% of the new-issue market by 2005. Credit crises, such as New York City in the mid- 1970s, the Washington Public Power Supply System in 1983, and Orange County in 1994, played a role in this expansion. Growth in the mutual fund market, accompanied by new technology that facilitated financial service delivery, increased investor appetite for bond insurance. This story would not be complete without discussing the role of ratings and rating agencies in the industry. Bond insurance played a systemic role in the 2007-2009 financial meltdown, which ultimately left only one insurer, Assured Guaranty, actively writing new business. Will the phoenix rise from the ashes? New entrant Build America Mutual believes so. A handful of other investors have seen the value of the product but have as yet been unable to obtain a rating necessary to launch a new business.
- Corporate bond insurance: feasibility and insurer risk assessment, Spahr, R. W., Sunderman, M. A., & Amalu, C. D. (1991). Corporate bond insurance: feasibility and insurer risk assessment.Journal of Risk and Insurance, 418-437. Bond insurance for municipalities has been available for more than ten years; however, corporate bond insurance has only recently received attention from potential insurers. This article uses a model to assess the pure risk premium for corporate bond insurance where both nonzero correlation between frequency and severity and nonzero correlation between individual risk units are allowed. The results suggest that corporate bond risk insurance could be offered by a third party insurer at a lower cost than the prevailing market default risk premium.