Expand Your Time Horizon on Bond Insurers

Within an existing portfolio, look at each credit in your municipal portfolio. Are there any that you own strictly because of the insurance? If so, you are probably best to get out now. Get the underlying rating of all your positions. If you are with a financial professional who cannot readily provide the underlyings ... well, that should tell you something.

As far as looking for opportunities, they will be there for investors with long investment horizons. But be aware of liquidity. Institutional investors are going to be better sellers of insured bonds for some time to come. Scrutiny from the public (in the case of publicly reported portfolio) or from a board (in the case of insurance companies) will cause portfolio managers to shun bonds where a downgrade is expected.

If you bid on an FSA-insured bond today, the odds are fair that you are the only bidder. And what does that tell you about your ability to sell the bond yourself? If you are going to bid on an FSA-insured bond, make sure you bid a price at which you are comfortable holding for the long-term.

Of course, if you do decide to look at an FSA-insured bond, you need to look at the underlying rating. Until recently, the market didn't price A underlying bonds much differently than those with a AA underlying ratings. That's going to change in a big way.

Investors will demand significantly more yield for an A-rated risk, even before FSA or Assured gets downgraded officially. Keep this in mind when bidding on bonds. Among non-insured bonds, the gap between A and AA is about 50bps, which is about 4% in price on a 10-year bond.

I had previously said I thought that municipal insurance would remain viable, despite the problems with FGIC, Ambac (ABK - commentary - Cramer's Take) and MBIA (MBIA - commentary - Cramer's Take). I think the fact that a large percentage of new issues in 2008 have carried insurance bears that out.

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At the time of publication, Graff had no positions in the stocks mentioned, although positions may change at any time.

Tom Graff is a Managing Director of Cavanaugh Capital Management, a registered investment advisor in Baltimore Maryland. The opinions expressed here are Graff's own and in no way are the statements of Cavanaugh Capital Management, and may or may not reflect the strategies being pursued for clients of Cavanaugh Capital Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Graff appreciates your feedback; click here to send him an email.