What US government guarantees are to the GSEs mortgage bonds, monoliner
insurance companies are to CDOs. Monoline insurance companies are also
referred to as ‘monoliner insurance’ or simply ‘monolines’ because they provide
only one product, a guarantee.
In contrast to protection via a CDS contract, where the protection seller receives
a regular credit spread, monoline insurance of a bond issue is purchased through
a one-time payment of an up-front premium. Not all bond issues qualify for insurance.
Each insurer has its own
credit criteria, although the categories reviewed
are
essentially
the same as those used by the rating agencies.
Issuers that meet certain credit criteria can purchase bond insurance policies
from monolines. The insurance guarantees the payment of principal and interest in
case an issuer defaults.
Bond ratings are based on the credit of the insurer rather than the underlying
credit of the issuer. A municipal bond insurance policy is intended to result in significant
interest cost savings,
depending on the issuer’s
underlying credit and market
conditions at the time of the bond sale. Interest cost savings
are attributable to
a
higher bond rating – and hence lower
credit spreads – as well
as enhanced liquidity
for insured bonds.
Insurance regulations prevent property/casualty insurance companies, life insurance
companies, and multiline insurance companies from offering financial guarantee
insurance. The
monoline industry claims that it has the advantage of a sole
focus
on capital markets.
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When the very first AAA monoline insurance, the American Municipal Bond Assurance
Corporation (AMBAC),
was
founded in 1971 it was
created to exclusively
insure municipal bonds. From
1971 to 2007 the number of insured bond issues
grew
astronomically.
In 1980, only 3% of all municipal bond issues were
insured
compared
to approximately
60% in 2007. An estimated 2.5 trillion USD of such
bonds
are presently outstanding of which more than half are insured. With
growing
popularity
of insurance, the number of insurers increased also. AMBAC
was
joined
by
several
other triple-A rated insurers. In addition, insurance companies with lower
ratings
entered the market
and offered to provide
insurance for bonds that were
too
small, unusual or had credit conditions that did not meet the risk criteria of AAA
insurers.
Over
time, due to the growing
competition and because growth
prospects
and
fees were
attractive,
many of the often privately held municipal bond insurers
started
to insure mortgage bonds and later also structured bonds such as CDOs as
well.
Source : Perguruan Tinggi Kedinasan