By Jeremy R. Cooke
Aug. 28 (Bloomberg) -- Investors are demanding higher yields on U.S. municipal bonds with AAA insurance on concern insurers' credit standing will suffer amid rising defaults on subprime mortgages.
The Lehman Brothers Insured Municipal Bond Index yielded 4.48 percent yesterday, 17 basis points more than the New York- based investment bank's gauge for uninsured, top-rated state and local government debt. On July 31, the yield premium, or spread, was 10 basis points. A basis point is 0.01 percentage point. Spreads on tax-exempt bonds guaranteed against default by MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. have widened 5 to 15 basis points or more, depending on the underlying credit, according to Citigroup Inc.
The shift was foreshadowed by rising costs of credit- default swaps linked to the insurers' debt on concern the subprime mortgage slump will trim profits, George Friedlander, municipal strategist at Citigroup in New York, said in a report.
``Until quite recently, it had not spilled over to weaker trading relationships for the insured bonds themselves,'' Friedlander wrote. Credit default swaps are used to speculate on the ability of companies to repay their debt.
The higher premium demanded for insured municipal bonds rather than those with so-called natural AAA ratings reflects the overall reassessment of risk and doesn't necessarily indicate insurers are less likely to pay claims, said Mike Pietronico, a New York-based portfolio manager for Evergreen Investments.
``Insured bonds have gotten caught in the downdraft with credit spreads overall,'' Pietronico said.
Adequate Capital
Standard & Poor's in a research report earlier this month said bond insurers have enough capital to protect their credit ratings against a ``highly stressed'' scenario for risky mortgages originated in 2006.
The four largest insurers of U.S. municipal debt -- MBIA, Ambac, FGIC and Dexia SA's Financial Security Assurance Inc. -- held a combined 77 percent market share during the first half, according to data compiled by Thomson Financial.
Each company's bond guarantee is rated AAA by S&P and Fitch Ratings and Aaa by Moody's Investors Service.
In the first six months of 2007, 48 percent of bonds issued by states and municipalities to fund schools, roads, sewers and other civic works carried insurance, Thomson figures show.
To contact the reporter on this story: Jeremy R. Cooke in New York at jcooke8@bloomberg.net .
