The business credit rating agencies (S&P, Moodys, Fitch) are taking a long, hard look at the credit ratings of the municipal bond insurers (MBIA, Ambac, etc.). There is a very good possibility that one or more of the municipal bond insurers could have their credit rating lowered.

When a municipality has less than a AAA credit rating, the municipality will have to pay a higher rate of interest to sell their bonds than a municipality with a higher credit rating. So many municipalities turn to bond insurance companies to get some interest rate relief. By paying the bond insurer a fee, the municipality will get the bond insurer's credit rating on their bonds, thereby paying a lower interest rate. The lower interest rate must offset the fee the municipality pays to the bond insurer, or the municipality won't sign on to the deal.

That raises two issues . . .

(1) Q: If a municipality issues an insured bond, and the bond assumes the credit rating of the insurer, how can we know the actual credit rating of the municipal bond without the insurance?

A1: Fitch gives some idea of the credit rating of some insured bonds on their website, without insurance. There are so many disclaimers, however, that one comes away wondering if the time spent was worth it.

 A2: One probably won't know unless these bonds are traded uninsured, on an open market, so that real, arms-length transactions can take place, in order to establish a price.

(2) Q: All these insurance agencies insure many types of bonds. What if the credit problems we're seeing resulted in these insurers having to pay out large sums of money for the guarantees they've made to things like CDOs, asset-backed securities, etc? What if these insurers didn't have the capital to pay these guarantees, and as a result went into bankruptcy themselves?

A: The underlying bonds would have to trade on their own merits. There would be no way to determine the rating/value of any municipal bond in advance. Most likely, all insured bonds would initially trade at a substantial discount to their actual value, as investors reacted to the news, until such time as investors had a chance to determine a realistic credit rating for each bond.

Given the above: Is this the time to own municipal bonds, knowing that the credit rating agencies (Fitch, S&P, Moodys) have announced they're paying particular attention to the companies that insure municipal (and other kinds of) bonds?

Mike

 

If I wanted municiple bonds, under current circumstances I would search for bonds that did not require insurance.  The yield might be lower than you can get elsewhere, but sometimes safety demands a premium. 

uh 

Good topic Mike. I have never had much reason to buy munis as I manage to stay in the tax bracket of zero or near zero income tax, so the tax advantage is lost for me. This does not add much to the conversation, but I offer it to explain why I seldom have much to say on the subject of munis.

Ben

 

 

Take a look at today's column on municipal bonds by Joe Mysak at bloomberg.com ( go to site map at bottom, then click on "opinion" to get to the columnists.
      I have avoided the problem by buying only munis that are escrowed to maturity by being backed entirely by treasuries. In other words, it's the best of both worlds: tax treatment of munis, by the creditworthiness of a treasury.  The yield is a bit less than other munis but it's worth it for the peace of mind.
    Historically the default rate of munis has been about 1% so the risk is small but who knows how badly some municipalities have run their budgets and what problems lurk in the future.