Many insurance companies specialize in financial guarantees and similar products that are used by debt issuers as a way of attracting investors. A Financial Guaranty in California can provide investors with an additional level of comfort that the investment will be repaid in the event that the securities issuer would not be able to fulfill the contractual obligation to make timely payments. It can also lower the cost of financing for issuers because the guarantee typically earns the security a higher credit rating and therefore lower interest rates.
Issuers often use a financial guaranty to lower costs of funds and diversify funding sources. Investors rely on the guaranty for payment of principal and interest when due, and also may benefit from good credit underwriting, as well as negotiated terms, surveillance and, where necessary, remediation.
Financial guaranty insurance is a type of credit protection
For investors in debt obligations such as municipal bonds, commercial mortgage-backed securities (CMBS), and auto or student loans, financial guaranty offers added protection. In essence, it provides financial recourse in the event of a default on the bond or other debt instruments. The terms “monoline,” “financial guaranty insurer,” and “bond insurer” are often used interchangeably to reference a company that provides this type of insurance solution.
The purchase of financial guaranty insurance generally allows the debt issuer to “wrap” the credit rating of the insurer around the debt obligation that is being issued in order to raise the credit rating of the debt, and thus qualify the debt for lower interest rates. For example, many municipalities use bond insurance to obtain an AAA rating, which lowers their borrowing costs, saving money on the overall transaction. For this to occur, it is essential that the financial guaranty insurer maintain a very high credit rating for wrapping the debt obligations it insures.
Remember that, insurance under Financial Guaranty in California allows debt issuers to lower their overall borrowing costs. This occurs because the premium paid for the insurance is less than the amount they can save through the lower interest rates that can be obtained with a higher credit rating. In the case of municipal bonds, the Association of Financial Guaranty Insurers (AFGI) estimates that, in nearly forty years, municipalities and their taxpayers have saved more than $35 billion in interest costs as a result of bond insurance.