NEW YORK, Sept 5 (Reuters) - U.S. municipal bonds insured by Radian Asset Assurance Inc. cheapened on Wednesday after its parent Radian Group Inc. (RDN.N: Quote, Profile , Research) and mortgage insurer MGIC Investment Corp. (MTG.N: Quote, Profile , Research) agreed to terminate their pending merger, citing market conditions.
MGIC agreed in February to acquire Radian in a $5.47 billion all-stock deal, but since then MGIC shares have lost more than half their value amid turmoil in the mortgage and housing markets.
The market expected the merger to fall through after both companies revealed in July that their $1.03 billion investment in subprime mortgage joint venture C-BASS could be worthless after defaults and margin calls mounted.
Since then there have been a lot of offerings of Radian-insured municipal bonds in the secondary market, said Dan Solender, manager of municipal bond investments at Lord, Abbett & Co. in Jersey City, New Jersey.
"A lot of people have been putting them out there," he said. "There is concern about a downgrade. Who knows what the odds are but there is a possibility. In this kind of market, too, there is all kinds of liquidity risk."
Fitch Ratings in July said it may cut the rating on 934 municipal bond issues insured by Radian Asset Assurance, Inc. after placing Radian and its units under review for downgrade.
Standard & Poor's Ratings Services said on Wednesday that Radian's "AA" rating is not under review because the bond insurer's capital position is largely independent of a mortgage insurance unit, which was placed on negative CreditWatch in August.
But bonds backed by Radian, which was the seventh largest insurer of munis in 2006, continue to trade at wide spreads.
The most recent example is a $9 million offering of bonds from the Millcreek-Richland Joint Authority in Pennsylvania. RBC Capital Markets priced these bonds on Wednesday to yield 5.52 percent in 2037.
That was 90 basis points over a benchmark triple-A yield scale compiled by Municipal Market Data.
Although Radian-insured bonds always traded 40 to 50 basis points cheaper than high-grade bonds because of its "AA" rating, the spread "was never this wide," Solender said.
All insured municipal bonds suffered in August amid concerns about the impact of subprime mortgages on financial guarantors, but Radian-insured bonds were one of the worst performers.
They continued to trade at wide spreads on Wednesday.
For example, a block of San Jose Redevelopment Agency, California, bonds carrying a 5 percent coupon and maturing in 2032 traded between 91.9 cents and 91.8 cents on the dollar at yields around 5.61 percent, according to BondDesk.
Last week, they traded at 97 and 98 cents on the dollar, while in early August and late July the bonds traded around 103 cents on the dollar.
In another trade, Sierra Kings Health Care District, California, bonds carrying a 5 percent coupon and maturing in 2037 traded between 90.4 cents and 90.3 cents on the dollar and yields of 5.67 and 5.68 percent. They traded in July at 5 percent.
An over $1 million block of South Carolina Educational Facilities Authority bonds with a 5.625 percent coupon due in 2031 traded at a yield as high 5.50 percent Wednesday, according to BondDesk. This yield is about 10 basis points higher than the last trade in mid-August and 110 basis points higher than July levels.
A trader in Chicago said some investors could be selling Radian-insured bonds for tax reasons to book looses and offset gains elsewhere.
