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GUARANTEEING SECURITY

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Business is good for both buyers and sellers of financial guarantee insurance.

Financial guarantee insurers claimed a greater percentage of the total municipal bond market in 1996, a year in which the number of bond issues also increased. The outlook for 1997 is also positive, though financial guarantee insurance companies continue to diversify into other areas-most notably international business and insuring asset-backed securities-for additional growth.

For municipalities looking to buy insurance for their bond offerings, the market remains competitive.

Municipal bond insurers traditionally confer their own AAA ratings on the lower-rated bonds they insure, which lowers municipalities' interest costs.

Under a new policy that was introduced last month by rating agency Standard & Poor's Corp., however, municipal bond issuers must now request and pay a fee to S&P for their bonds to carry an insurer's AAA rating.

Insured AAA bonds typically trade at the same level as "natural," or uninsured, strong A or AA bonds.

In 1996, insured bonds totaled $85 billion, or 46.3%, of the total $183.7 billion in new bonds issued, according to the New York-based Public Securities Assn.

This was a 24.1% increase over the $68.5 billion in new bonds insured in 1995, when a total of $160.3 billion in new municipal bonds were issued. Insured bonds accounted for 42.3% of the overall volume in 1995.

The financial guarantee insurance industry, which had a 24.7% combined ratio in first-half 1996, continues to enjoy relatively low losses. Even the recent financial troubles of the city of Miami, which has insured bonds, has caused little concern.

That was an "isolated incident and as a single credit is not going to have a material impact on any of the larger bond insurers," said Brady N. Tournillon, an analyst with Fitch Investors Service L.P. in New York.

In fact, "it validates the value of the insurance," said David A. Buzen, executive vp and chief financial officer of Capital Re Corp., a financial guarantee reinsurer.

"I think on balance they will continue to perform well," Anne Ross, vp and manager of research at Roosevelt & Cross in New York, said of the financial guarantee insurers.

The financial guarantee insurance market has shown some stable growth rates and that is expected to continue, added Sabra Brinkmann, vp at Hartford, Conn.-based Conning & Co.

The core growth rate in the industry is perceived to be 6% to 8%.

"The wild card will be the level of refunding activity," said Ms. Brinkmann. There were a total of $57.1 billion in refundings last year, a 19.5% increase over $47.8 billion in 1995.

Refundings occur when a bond is retired by issuing new securities, generally at a lower interest rate. They benefit muni bond insurers because when an insured bond is refunded, the unearned premium associated with it is earned immediately rather than over the remaining life of the bond.

However, there is some concern that insured bonds have become too much of a commodity item.

"Anything that comes through the spigot seems to get insured," said Ms. Ross. Insured bonds have "just become a commodity."

Mr. Tournillon agreed. "It makes it harder to compete on anything other than price, so in that respect it's not good," he said, though he added that with volume up last year, "it did alleviate some of the pricing pressure."

But, David H. Elliott, chairman and CEO of Armonk, N.Y.-based MBIA Inc., disagreed that the insurance has become a commodity. "I think it's still very important" in terms of the company that is providing the guarantee, its trading value, reputation, track record, historic performance and capital position, he said.

At the same time, he believes the insured portion of the muni bond market could grow even higher. "There's no artificial or arbitrary feeling on how high penetration could grow," with the only limit the credit quality of the issues to be insured, he said.

Capital Re's Mr. Buzen agreed. Given the infrastructure needs and the continuing focus on credit quality, the trend toward insurance is unlikely to diminish, he said. In the long term, a 50% penetration rate is a "good number," but in any given year, it could be significantly above that, he said.

But not all observers see more growth.

"I think the insured portion of the market is not going to increase a lot more than it has," said Vernon M. Endo, managing director-bond insurance at Financial Guaranty Insurance Co. in New York.

Some of the players in the market have made significant strategic changes.

There has been a shift in competitive activity within the market because of a decision by FGIC to move away from insuring health care and utility issues and to focus on a more conservative strategy of insuring general obligation, water and sewer and transportation bonds.

"It became apparent to us we needed to proceed with some caution in approaching certain sectors because premium levels were such there was not enough room for error. . .the risk-reward matrix got a little bit out of whack, if you will," said Mr. Endo.

FGIC's strategy means that "the pricing on GOs is a lot more competitive and on utility and health care a lot more attractive, but overall you've got the same four player slugging it out and trying to figure out how to make money," said Ms. Brinkmann.

The 1995 merger between San Francisco-based Capital Guaranty Corp. with a unit of New York-based Financial Security Assurance Holdings Ltd. (BI, Aug. 28, 1995), created a more effective fourth competitor against the "big three," which are FGIC, MBIA, and New York-based AMBAC Indemnity Corp. However, the combination did not have a significant impact on the market's overall competitiveness, observers say.

"I don't have a sense it was a major impact on the market," said Richard P. Smith, senior vp at Standard & Poor's Insurance Rating Services in New York.

FSA had originally focused on the corporate sector before expanding into the muni bond market in 1990. Its merger with Capital Guaranty, which has always focused on insuring municipal bonds, gave it a stronger presence in that market.

"It's a very important element in our strategic plan to have a significant seat at the table in the municipal market," said Roger K. Taylor, FSA's chief operating officer.

Another company going in a new direction is the Washington-based College Construction Loan Insurance Assn., better known as Connie Lee.

The insurer, which has been owned in part by the federal government and has been restricted to insuring obligations of education and health care-related issues, can now expand its scope and privatize under provisions of legislation that President Clinton signed last September.

This means the company is going to try to find a new niche "and I have to wonder where they're going to find that business," said Richard A. Ciccarone, senior vp at Van Kampen American Capital in Oakbrook Terrace, Ill.

"Connie Lee would have a difficult time competing as a full-service bond insurer going head to head with the other larger primaries," said Fitch's Mr. Tournillon.

A Connie Lee official could not be reached for comment on the insurer's current plans.

The fifth monoline insurer, New York-based Capital Markets Assurance Corp., focuses on non-municipal structured finance and writes only a small proportion of its business in the municipal market.

The market overall remains competitive.

"It did seem like there continued to be pressure on premium rates in the municipal bond area," said Ralph Aurora, senior vp-financial guarantee group at rating agency Duff & Phelps in New York. "It's something that raises concern," he said.

"My sense is that rates are stable, not declining, but not going up at all," said S&P's Mr. Smith. "Some people would argue they're about as low as they should go, that the insurer really can't afford to lower them any longer without jeopardizing their ability to generate capital in the long run."

"The competition is the same as it has been in the past couple of years," said MBIA's Mr. Elliott, adding the insurer has still managed to increase its rates as well as rates of return.

"I don't think you're going to see big changes in premium pricings" in 1997, said Nicholas Ferreri, vp with rating agency Moody's Investors Service Inc. in New York. He added, "If anything, I think the competition in the muni bond market is reflective of why you're seeing bond insurers moving into asset-backed and international" business.

There has been a growing focus in alternative areas as muni bond insurers look for additional growth opportunities to offset the relatively slow growth in the competitive muni bond sector.

Building a diversified book of business lessens financial guarantee insurers' and reinsurers' vulnerability to fluctuations in municipal bond issuance, said Mr. Taylor of FSA, which is active in diversification.

This means insurers will not be put in a position where they "have to go crazy" if there is a major downturn in new municipal bond volume; they can simply change their focus, he said. "The industry is a stronger industry by virtue of this growth and diversification."