Munis Return To Investor Favor Despite Subprime,Insurer Woes; Economic jitters spell higher Treasury prices

Feb.15, 2008 in Market Outlook

Munis Return To Investor Favor Despite Subprime,Insurer Woes

Last Update: 2/15/2008 2:36:41 PM

By Leslie Wines

OF THE ASSOCIATED PRESS

NEW YORK (AP)–Many classes of bonds are being punished for the problems of
subprime mortgage debt, but at least one segment of the market is expected to
perform well this year: long-term, investment-grade municipal bonds.

The $2.6 trillion municipal bond market generally is considered as safe as
Treasurys because most local governments make debt payments their top fiscal
priority. Even New Orleans met obligations on its bonds after Hurricane Katrina.

Munis, as they are known, are issued by cities, counties, states, school and
water districts, schools and hospitals. They are popular because of their safety
premium and because they create funding for favorite local projects. But their
biggest selling point probably is that many are not taxable.

“If you want to buy a defensible asset that hasn’t rallied, munis are the place
to be,” said R.J. Gallo, a portfolio manager at Federated Investment Management
Co.

Investors are also buying munis because they are aware that assets backed by bad
mortgage debt remain unattractively risky.

“A State of Washington bond is a very solid investment compared to the CDOs and
all the other synthetic deals,” said Michael Murphy, treasurer of the state,
referring to collateralized debt obligations, a complex asset that often includes
toxic subprime debt.

Nonetheless, muni prices have come under pressure of late, as munis get tarred
with the same brush as riskier credits. Many analysts think munis are unfairly
being caught up in the problems of the insurers who back about 40% of this
market.

Bond insurers like Ambac Financial Group Inc. (ABK) and MBIA Inc. (MBI) remain in
limbo as they scramble for the financing that would allow them to operate as
usual, while FGIC is considering a split that will separate the healthy municipal
bonds it backs from subprime assets.

The market’s problems have also contaminated an unlikely niche of the municipal
market - auction-rate securities. This $330 billion short-term muni bond market
segment normally performs like clockwork. But this week queasy buyers went on
strike, leading to hundreds of auction failures, because troubled insurers back
many of these deals.

The auction failures were unprecedented and left short-term financing in disarray
at schools, student loan companies and transportation authorities around the
country. An auction failure does not throw the securities into default, but it
does drive up borrowing rates severely, since the interest rate on such
instruments changes every time they are sold - and soars if they are not sold.

In the last few days, the Port Authority of New York and New Jersey saw its
short-term interest rate on some notes increase fivefold to 20% after a failed
auction, while a Michigan student loan program suspended operations to avoid the
higher rate.

Yet throughout the insurers’ drama, strong demand persisted for top-quality
munis. This is because the selloffs sent prices lower and yields higher, making
them a good buy. Jonathan Lewis, a principal in Samson Capital, said many munis
currently now yield much more than Treasurys or corporate bonds of comparable
maturities.

For example, New York City’s Metropolitan Transportation Authority this week sold
$1 billion in bonds, including two-year notes with a yield of 2.35%, well above
the 1.90% yield of a two-year Treasury on Thursday. Many portions of the MTA
offering were oversubscribed, meaning bidders had to be turned away.

Other 2008 issues that have made it to market fared well, including long-term
offerings from the University of California, Chicago’s O’Hare International
Airport and New York’s Empire State Development Corp.

Investors’ comfort with munis sometimes is enhanced by the fact that they finance
local institutions and projects they can track. About 35% of municipal bonds are
purchased by investors with direct knowledge of local issuers, according to
Federated’s Gallo. Investors must buy bonds through a broker as there is no way
to buy one directly from a state or city.

Treasurys gain on fresh economic, credit jitters

By Polya Lesova, MarketWatch

Last Update: 1:06 PM ET Feb 15, 2008

NEW YORK (MarketWatch) — Treasury prices rose Friday, putting yields under
pressure, as investors fled to the safety of government debt on rekindled worries
about the U.S. economy and the credit markets.

The benchmark 10-year Treasury note gained 9/32 at 97 21/32, with a yield ($TNX)
of 3.783%.

The 30-year bond surged 25/32 at 96 14/32 to yield ($TYX) 4.595%.

The two-year note was flat at 100 14/32, yielding 1.903%.

“Yields slumped back down to session lows, propelled by the downturn in stocks
and the latest round of weak University of Michigan data, which followed closely
on the heels of damp production and Empire State reports,” said analysts at
Action Economics.

On Wall Street, U.S. stocks traded broadly lower, extending Thursday’s sharp
losses, as investors turned to debt instruments. See Market Snapshot.
Click for Detail

Providing grist for bond traders, a report out earlier Friday showed U.S.
consumer sentiment dropped in February, adding to worries about recessionary
risks. See Economic Report.
Click for Detail

Also, the Federal Reserve said that output at the nation’s factories, mines and
utilities edged up a mere 0.1% in January, still enough to mark the third
consecutive month of gains. See full story.
Click for Detail

Separately, data out from the Federal Reserve Bank of New York showed that
regional manufacturing activity for February fell to the weakest levels seen in
close to three years. Read more.
Click for Detail

And the Labor Department reported that the cost of goods imported in the country
climbed 1.7% in January, powered largely by rising energy prices. Read more.
Click for Detail

FGIC wants to be split into two companies

The Treasurys market also kept an eye out for developments involving bond
insurers.

Along these lines, FGIC Corp. notified New York regulators that it wants to be
split into two companies, the state’s insurance commissioner said. See full
story.
Click for Detail

On Thursday, Moody’s Investors Service cut its ratings on FGIC, saying its
position was weaker than other struggling bond insurers MBIA Inc. (MBI) and Ambac
Financial Group (ABK). Read full story.
Click for Detail

“In 25 years of working in this business, I don’t believe I have ever seen more
market disruption from so many different sources,” said Kevin Giddis, managing
director of fixed income trading at Morgan Keegan & co., in a note Friday.

“Who ever thought that all of the monoline insurers could fall so far so fast?
Even worse, who would have ever thought the mere mention of the loss of its AAA
rating would turn liquidity into a distant function?” Giddis said.

In yet another sign of trouble, auction-rate securities, the latest minefield in
the credit market, may soon claim a new victim: closed-end funds.

J.P. Morgan analysts said Thursday they anticipated the costs from some of these
funds, which had issued auction-rate securities as a source of cheap financing,
could increase after the market for these securities nearly dried up.

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