What is the 'American Municipal Bond Assurance Corporation'

The American Municipal Bond Assurance Corporation offers insurance against default on municipal bond offerings.

BREAKING DOWN 'American Municipal Bond Assurance Corporation'

The American Municipal Bond Assurance Corporation (Ambac) began in 1971 as a subsidiary of MGIC Investment Corporation of Milwaukee. It was the first company to offer insurance for issuers of municipal bonds. A municipal bond issuer may purchase insurance coverage in order to increase investor confidence that principal and interest payments will be made in full and on time if the issuer defaults. The insurance acts as a bulwark against default, reducing the risk and raising the credit rating of the bonds issued. The extra confidence generated by this coverage means insured bonds can command higher prices, pay lower interest rates and generally enjoy more liquidity than uninsured bonds.

Ambac remains among the major bond insurers and the market for insurance continues to thrive, though Ambac’s credit ratings declined precipitously following the financial crisis of 2008. The organization currently goes under the name Ambac Assurance Corporation and serves as a major operating unit of Ambac Financial Group, a New York-based holding company.

Bond Insurance

Bond insurance works in a similar fashion to any other insurance policy. Issuers take out insurance against default and a bond insurer prices premium payments based upon the risk it perceives from the issuer. If the issuer fails to make timely payments during the duration of the bond, the insurer must make those payments instead. This dynamic means an investor typically considers an insured bond to have the same credit rating as the firm insuring the bond, regardless of the credit rating of the underlying securities. From an investor’s point of view, the only risk of default comes from the chance that the bond insurer fails to make payments. Generally, bond insurers only cover securities whose underlying ratings lie in investment grade territory, or no lower than BBB.

While bond issuers must pay insurance premiums, the improved creditworthiness of the debt can yield significant benefits by improving the terms of the loan, primarily by lowering yields or by expanding an issuer’s access to debt markets. To the extent that those improved loan terms reduce the cost of borrowing more than the increased cost generated by insurance premiums, the bond issuer comes out ahead. In practical terms, investors also wind up paying for insurance premiums to the extent that they take lower returns on debt that would expose them to higher risk, and therefore yield higher returns, if it were uninsured.

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