Subprime Municipal Bond Fallout

Ulli Uncategorized 4 Comments

The Subprime/credit crisis of 2007 was bound to move into unexpected areas as well. MarketWatch’s feature “Moody’s warning ripples through municipal bond market” describes the unprecedented effect on the muni bond market.

Moody’s put the triple-A ratings of Financial Guarantee Insurance Company (FGIC) and XL Capital Assurance on review for a possible downgrade after re-evaluating the companies’ exposure to potential Subprime mortgage losses.

The story goes on to say:

“By issuing warnings on FGIC and XL Capital Assurance, the agency is also putting more than 90,000 securities that the companies had guaranteed on review for a possible downgrade, according to global fixed-income analysts at UBS.

The majority of those securities — 89,709 — are in the public finance sector, the analysts said, noting that this was “unprecedented” in the municipal bond market.

Bond insurers agree to pay principal and interest when due in a timely manner in the event of a default. It’s a $2.3 trillion business that offers a credit-rating boost to municipalities and other issuers that don’t have triple-A ratings.

But if a bond insurer loses its triple-A rating, the securities it has guaranteed also lose their top rating.

“I can’t think of a credit watch action in my 32 years in the muni bond market that had that many securities involved,” Richard Larkin, a municipal bond expert at JB Hanauer & Co., said in an interview on Monday.”

Why should you care? If you hold any municipal bonds, the rating, and therefore its value, could be adversely affected. Read the above bold part again!

I have used municipal funds over the years for my own account and that of clients to generate tax-free income. When the Subprime news first made headlines during this past summer, we started selling off most holdings since many funds slipped off their highs considerably. At this time, we are only holding a few funds, which I will liquidate on a need-to basis.

Let me go on record by saying that at this point I no longer can recommend new investments in muni bonds. While I may change my view in the future, right now I want to stay aside and watch how this debacle plays out—and I prefer doing that without real money on the line.

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Comments 4

  1. Ulli, this is a very scary but interesting message. But not all municipal get insured. What about them? I don’t know mutual funds, but there are a lot of close-end funds, like nvx, nvc… which as far as I know not insured. What do you think?
    Thanks

  2. I cant’t be sure how far reaching the fallout effect will be, if there even is one. All I am saying is that there is great uncertainty with a situation that has no historical precedent. So I prefer to err on the side of caution.

    Ulli…

  3. the default rate on muny bonds is miniscule and a rating agency isn’t need to insure the bonds if you stay with highly rated GO bonds. I believe there is a buying opportunity for muny’s at this time.

  4. Yes, the default rate is very low. My point is that munis have been sliding all year and with more potential fallout from the credit crisis, no one can be sure where the bottom is. I prefer to be on the sidelines and not try to catch a falling knife.

    Ulli…

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