Insurer Woes Put Munis in Bargain Bin
By DIYA GULLAPALLI and SHEFALI ANAND
December 22, 2007; Page B1
Bad news about bond insurers in recent days sent mutual-fund managers racing into the market -- scooping up insured municipal bonds at a steal.
Individual investors, too, might want to follow suit. But only if they can stomach some surprising chaos in this traditionally sleepy corner of the market.
In recent months, bond insurers -- which guarantee the principal and interest payments on various types of debt -- have gotten clobbered amid uncertainty about some messy types of mortgage securities they have backed. The situation is raising questions about whether the insurers are financially strong enough to cover any potential losses.
On Friday, Fitch Ratings said it is reviewing bond insurer Ambac Financial Group Inc. for a potential downgrade. It also put the triple-A rating on MBIA Inc.'s insurance business on review Thursday.
Uncertainty about insurers like these is hurting the prices of the bonds they insure -- including muni bonds, even though they remain relatively safe, given the rarity of their defaults.
The upshot: It's a potential buying opportunity, particularly in the market for insured municipal bonds.
Munis are government-issued debt to finance projects such as road or other improvements. Not all carry bond insurance, but those that do usually trade at higher prices than their uninsured cousins, because of the extra protection offered.
Now, in some cases, the opposite is true because of the troubles at bond insurers. Some mutual-fund managers say they have never seen such deep price discounts. For a more aggressive bond investor, this could spell opportunities to lock in attractive muni-bond deals.
"We've kind of gotten sucked into this whole flurry of credit concerns that's unduly affected some very high-quality securities," says Reid Smith of the Vanguard Group.
Monday, Mr. Smith's team noticed that California Economic Recovery bonds insured by bond insurer Financial Guaranty Insurance Co. were trading at a lower price, and 0.05 percentage-point higher yield, than a similar bond without insurance.
Nuveen Investments municipal-bond-fund manager John Miller says he has similarly been buying MBIA-insured bonds now trading at attractive prices.
"Insured municipal bonds in general over the last several weeks have continued to get cheaper," he says, adding: "This is the widest spread I can recall," referring to the difference between certain yields.
In particular, offerings such as some investment-grade hospital bonds have been hammered, he says.
The opportunities come just as municipal bonds are also trading at a particular bargain compared with U.S. Treasury bonds. Municipal bonds typically yield less than U.S. Treasurys because of the fact that they have some tax advantages. However, in recent days, municipal bonds have posted yields at a premium to U.S. Treasurys.
In the second half of November, municipal bonds traded at about the same yields as U.S. Treasurys or higher for two weeks, then hit a comparative high Nov. 26, according to a report from CreditSights.
And Tax-Free, Too
"Right now, you have muni bonds that are yielding what Treasury bonds are yielding, despite the fact that they give tax-free income," says Lewis Altfest, a New York-based fee-only planner. Thus, on an after-tax basis their yields are much higher.
Despite the buys in the municipal market, so far investors aren't biting. This past week, municipal-bond funds reported their sixth straight week of net outflows -- the longest string of consecutive weeks in two years.
Meanwhile, the average high-quality municipal-bond fund is set to have its worst calendar-year return since 1999, up only 1.8% so far this year through Wednesday, according to Morningstar Inc.
For individual investors, the opportunities presented in municipal bonds right now can be confusing because in many ways their market is moving counter to typical patterns.
Risks still remain, including that municipal-bond prices could continue moving lower because of bond insurers' challenges. The risk to investors is that they jump in too early.
If insurers do get downgraded, as ACA Capital Holdings Inc. did in the past week, it could trigger waves of repricing for the municipal bonds they insure. Some investors are also beginning to see dangers in other types of structured securities held in municipal offerings, like complex tender-option bonds or variable-rate demand obligations, according to CreditSights.
Many fund managers are cautioning investors to separate the risks associated with the bond insurers' falling stock prices from those of the actual municipal bonds that the insurers guarantee. The 10-year default rate on investment-grade municipal bonds is about 0.1%, according to Moody's.
So far there haven't been signs that local issuers are having trouble making payments on their municipal bonds, as was the case this year with some bonds backed by mortgages.
Insurance Even Needed?
Recent events are even prompting some money managers to debate the need for municipal-bond insurance. They point out that the insurance coverage, which should enhance the bond's appeal, "is actually making things worse," says Vanguard's Mr. Smith. A huge chunk of the bonds insured by the insurance companies are already rated investment-grade by third-party rating firms.
"It really starts to make you question whether you need insurance," says Brian Kazanchy of RegentAtlantic Capital Advisors LLC in New Jersey.
Investors whose funds have had a negative net-asset value this year may consider harvesting capital losses by selling the funds this year, and then returning to the funds after 31 days.
Mr. Kazanchy suggests that for the interim month, investors may park the money in a municipal exchange-traded fund, like the iShares S&P National Municipal Bond exchange-traded fund. Several such municipal-bond ETFs have come to market this year.
online.wsj.com
A House of Cards
Saturday, December 22, 2007; Posted: 07:10 AM
Dec 22, 2007 (Zacks Investment Research via COMTEX)
Recently, a small financial guarantee insurance firm ACA Capital (ACA) was downgraded to CCC (just above default, the junkiest of junk). The impact is just starting to be felt as banks line up at the confessional faster than Mafia members diagnosed with terminal cancer.
So far, the fallout from the near collapse of this firm that is barely an asterisk in the financial guarantee business includes a $3.6 billion writedown at Credit Agricole, the second largest bank in France, and exposure of $3.5 billion at CIBC, the big Canadian bank.
Now comes word that MBIA (MBI) has exposure to $8.1 billion of CDO squareds. CDO^2 are CDOs of CDOs, and in this environment, that paper is not even fit for use in the smallest room in the house. CDOs have been at the heart of the $70 billion or so in writedowns taken so far by the big banks. CDO^2 are leveraged versions of it, and the writedowns the banks have been taking on that paper is massive. { a bit misunderstood or perhaps misleading- CDO's of CDO's don't require more leverage but usually create more subordination for lower tranches. CPDO's are another animal. For those who know, think of CPDO's of Mez CDO's... }
That is part of MBIA's total exposure to CDOs of $30 billion. At the end of September, MBIA had a book value of $6.4 billion. In other words, the CDO^2 exposure alone could easily wipe it out. Keep in mind that this is an unusual business. For most firms, having a AAA rating is nice, but really no big deal if you get cut to AA or A -- sure you pay a little bit more when you borrow, and lose some bragging rights. However, if MBIA were to lose its AAA rating, it would essentially be out of business. The whole idea behind the firm is to rent its balance sheet out.
It turns a natural A-rated municipal bond into a AAA insured municipal bond. If the firm isn't AAA, then what it insures is not AAA either. It was a great business as long as they stuck to the muni bond business, but over the last decade they branched out into structured finance. Now its coming back to bite them. The rating agencies have put it and its major competitors FGIC and Ambac (ABK) on notice that they are in danger of being downgraded unless they raise more capital and soon.
On December 10th, MBIA announced a deal where they would get $1 billion of new capital from the private equity firm Warburg Pincus. This raises the question whether this exposure to CDO^2 was disclosed to Warburg Pincus; if it wasn't, it is probably grounds to shelve the deal.
{Jeez- it's already known WP knew of the multisector CDO exposure which is documented in the August 07 presentation on MBI's Investor relations page... }
If it was, it sure violates the spirit of Reg FD (not being a securities lawyer I will not judge if it violates the letter of it).The current book value of $6.4 billion supports guarantees of the timely payment of principal and interest of $652 billion of municipal and structured finance debt. Every last cent of that debt would be downgraded if MBIA is downgraded.
Credit-default swaps for MBIA soared as much as 145 basis points to 625 basis points, the widest ever, before narrowing to 560 basis points. That means it costs $560,000 a year for an investor to protect $10 million in MBIA bonds from default for five years. Think about that for a minute: this is supposed to be a AAA company, but it costs you 5.60% a year for protection against default. That sounds more like a B credit to me than a AAA. The stock was down sharply today, but don't get sucked in.
Oh, and if you are holding 'insured' muni bond funds, they are not any where near as safe as you think they are. If billions have to be written down because an insignificant gnat like ACA fails, then if MBIA or ABK go down, this whole house of cards is history.
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