No Insurance, but Lots of Value

By TOM SULLIVAN

THE TYPICALLY SLEEPY municipal-bond market, a sector favored by Mom and Pop for its safety and usually low volatility, has become something of a nightmare lately. Now it's time to wake up and take stock of some pretty attractive investments.

The big fear right now is that muni insurers who place triple-A ratings on municipal debt might be downgraded by Moody's and Fitch for also insuring collateralized debt obligations -- those bonds, sliced and diced into new bonds, that are collapsing in value due to their heavy exposure to subprime mortgages.

About half of the $2.4 trillion muni market is insured, because higher ratings mean lower coupons. But "a double-A credit shouldn't have to get insurance," says Ken Woods, CEO of Atlanta-based Asset Preservation Advisors. High-quality uninsured munis, on average, have a 0.0001% chance of default, he says.

Case in point: The Schertz-Cibolo-University City independent school districts in Texas scrapped plans last week to sell insured munis, and instead sold $82.2 million of bonds rated a strong single-A by Moody's and Fitch, with top yields of 5.50%. All yields were repriced 0.03 of a percentage point lower because the deal was six times oversubscribed. A good price, apparently, trumps insurance.

Certain other uninsured munis are attractive. Yields on some California long-dated general-obligation bonds topped the psychologically important 5% mark recently as the high-tax state looks at a $10 billion budget deficit. Some New York State-related debt is trading at 0.10 to 0.12 of a percentage point above the consensus Municipal Market Advisers triple-A scale, more than its usual 0.05-to-0.10-point margin.

Dan Soldender, a portfolio manager at Lord Abbett, likes riskier high-yield munis, which have underperformed taxable debt. He's bargain-hunting for debt hospital and charter-school debt and tobacco bonds-those backed by payments from a national settlement with tobacco companies. "There's a lot of value in the yields and, historically, they've performed well," he says.

As for muni-bond insurers: Paging Warren Buffett!

IN THE TREASURY market, 10-year yields dropped to 4.15% from to 4.21% the week before, while two-year yields fell to 3.30 from 3.42%. Interest-rate futures markets last week gave 100% odds to a cut in the federal-funds rate on Dec. 11, to 4.25% from the current 4.50%.

But two voting members of the Federal Open Market Committee last week warned the market may be getting ahead of itself. The head of the St. Louis Fed, William Poole, told Dow Jones Newswires that only unexpectedly weak fourth-quarter economic data would prompt a cut, and Fed Gov. Randall Kroszner poured even colder water on rate-cut hopes in a speech to the Institute of International Finance in New York. He said that the Fed wouldn't be inclined to lower rates again, even if the economy hits a "rough patch," as he expects.

The Fed has cut its target rate by 0.75 of a percentage point at the past two meetings, starting with a half-point cut in September, followed by quarter-point reduction in October. But, to paraphrase Churchill, that may have been the beginning and the end.