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Stocks & Bonds

Insured Munis Take It on the Chin

The subprime-mortgage mess claims new and unlikely victims.

The latest innocent bystanders caught in the subprime-mortgage crossfire are holders of insured municipal bonds. These normally safe bonds have top triple-A ratings because their issuers bought insurance that guarantees payment of principal and interest.

Problem is, the same insurers who stand behind tax-free munis have also backed troubled bond issues tied to subprime mortgages. Some of those insurers are now in danger of losing their own triple-A ratings, which means the bonds they guarantee would no longer carry the top rating.

In this scenario, holders of insured munis would still receive interest payments, but the market value of the bonds would dip to reflect the increased -- though still remote -- risk of default. In fact, prices of insured bonds have already fallen.

Triple-A-rated insured munis, which yielded around 0.1 percentage point above comparable Treasuries before the insurers' troubles surfaced, recently yielded a half-percentage point more, says Josh Gonze, of Thornburg Investment Management. Because bond yields and prices move in opposite directions, the higher yields mean prices have fallen.


If you're in the market for munis, you could avoid insured bonds and buy only those that are triple-A-rated on their own merits. But demand for those relatively scarce bonds is high, so you'll have to pay higher prices and settle for lower yields to get them, says Gonze.

Paradoxically, many insured bonds are good values now because they've lost value. "There's been a tremendous overreaction" to the danger of an insurer downgrade, says Thomas Albright, who runs two muni funds for Aquila Investment Management. But buying an insured bond nowadays requires a keen understanding of the issue's under-lying quality as well as the financial strength of the insurer. It's a task better left to the pros.