Muni Investors Unfazed by Subprime...

This year has seen a short-seller accelerate his assault on MBIA Inc., the biggest bond insurer, and analysts at the credit rating companies ask if the financial guarantors' vulnerability to subprime mortgages might result in damage to their ratings.

You would think that this concern might translate into investors losing their appetite for insured municipal bonds.

You would be wrong.

So far this year, almost 50 percent of all new state and municipal bonds have been insured, according to the Bond Buyer newspaper -- $157 billion of the $319 billion that were sold through September. By the way, that $319 billion makes 2007 already the sixth-busiest year on record, with a full quarter of the year to go.

That 50 percent figure is remarkable in its own right, if you consider that most municipal bonds are investment grade and rarely default. It is also the average proportion of municipal bonds that have been insured every year so far this decade.

If anything, the drumbeat of bad news got louder in the waning days of summer. That didn't seem to blunt bond buyers' enthusiasm for insured debt. Of the $27 billion of municipal bonds sold in September, $15.4 billion, or 55 percent, were insured.

Protect the Franchise

October is probably on a similar pace. Just taking a look at last week's calendar of bond sales, choosing deals entirely at random, I see that the Arizona School Facilities Board's $82.8 million in revenue bonds were insured by Ambac Financial Group Inc. So were the Commerce, California, Joint Powers Financing Authority's $64.8 million in revenue bonds. Almost all of the $1 billion in revenue bonds sold by the New York State Thruway Authority were backed either by MBIA or FGIC Corp.

``There is currently no significant difference in offering yields or bids between the big four bond insurers,'' Citigroup's Municipal Investor Monthly commented in its October edition, after observing that the only product the bond insurers sell is their triple-A rating. ``Given the likelihood that they would be able to maintain and support the triple-A rating even under more extreme conditions, this is not a surprising result.''

The rating companies, which haven't exactly covered themselves with glory during this whole subprime mortgage episode, have also examined the bond insurers. On Sept. 25, Moody's Investors Service noted that ``a highly-rated financial guarantor with a strong ongoing franchise would likely take whatever action is feasible to preserve its rating during times of stress.''

Sky Falling

That's reassuring, I guess, if you still believe in the opinions of the rating companies. Moody's also went on to say that, if anything, current events ``are likely to be a positive catalyst for financial guarantor business growth over the medium term, as credit re-prices to levels that increase demand for their core product.''

That's a fancy way of saying that investors come to value bond insurance even more in times of turmoil, let alone disaster.

What happens is that after an issuer defaults and a bond insurer comes in to pick up the pieces, everyone panics and thinks it's the end of the world as we know it, and that all the insurers are going to go bust. Then, three days later, after the sky has inexplicably failed to fall, you see everything, even the safest of bonds, being insured.

Place Your Bets

That wouldn't happen if there was even the slightest worry about one of the insurers, and by ``slightest,'' I mean not a downgrade, but merely the threat of a downgrade, by one of the rating companies putting an insurer's triple-A rating on watch.

Even Pershing Square Capital Management's well-documented evisceration of MBIA on March 2 has failed to deter investors who want insured munis. Stock investors may be thinking twice about bond insurers; not bond buyers, not so far.

There's an element of faith here. Bond buyers are making two bets. They are wagering that the insurers will be able to raise the money they need to bolster capital and preserve their triple-A ratings. They also are betting that the insurers haven't thrown their conservative underwriting standards out the window.

And then there's the matter of numbers. To issuers, the bond insurers don't offer insurance so much as credit enhancement. Under its own rating, a municipality might be able to borrow money for 20 years at 4.20 percent. If, on the other hand, the issuer buys insurance, it may be able to borrow at 3.90 percent, or 4 percent. The savings has to be there, or you wouldn't see 55 percent of the new-issue market insured.

If only these guys would stick to their knitting, and didn't get involved in riskier credits or in businesses they don't understand, they would be better off, and so would the market. So far, though, nobody has revoked their licenses to keep printing money by insuring munis. We will probably see 70 percent of the market insured one of these days. There's no accounting for taste.

To contact the writer of this column: Joe Mysak in New York at jmysakjr@bloomberg.net