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Take a look at investing in bonds

They're losing lots of money thanks to the mortgage market. The turmoil might make it a good time to buy municipal bonds.

By Helen Huntley, Times Personal Finance Editor
Published February 10, 2008

I hate to sound like a curmudgeon, but you know, some of the old ways really were better. Wasn't it smarter to lend money only to people who had a reasonable chance of repaying it? Didn't it make more sense to give AAA credit ratings to securities that actually were AAA? And shouldn't we all have paid a lot more attention to risk?

The defaults that have crippled the mortgage markets are causing problems for bond insurers, who no longer look like the towers of financial strength we expected them to be. Bond investors are going back to the old ways. That means examining the underlying creditworthiness of the corporations and government bodies that issue bonds.

"If I were buying a bond, I wouldn't even look at the insurance right now," said Greg Ghodsi, a senior vice president with Raymond James & Associates in Tampa. "Just assume there isn't insurance and look at the underlying credit."

He offers this example of how bond insurance worked in the past: When the city of Sarasota decided to raise about $46-million by selling bonds last year, it qualified on its own for an AA rating. But by buying bond insurance from MBIA Inc., the city was able to market its bonds with an AAA enhanced rating. The city saved about $110,000 because investors were willing to accept a lower interest rate on AAA bonds. Deals like those propelled bond insurance into a $2-trillion market as issuers looked for savings and investors bought into the belt-and-suspenders concept of risk protection.

But lately bond insurers have been losing lots of money thanks largely to mistakes they made insuring mortgage-backed securities. MBIA lost $2.3-billion in the fourth quarter, putting its top credit rating in jeopardy. If the credit-rating agencies downgrade MBIA or any other insurer, bonds that carry the company's insurance will be downgraded.

Ghodsi said the bond insurance market has changed so drastically in the past few months that insured bonds may no longer have any financial advantage for government issuers.

The turmoil means this is a bad time to sell municipal bonds, but it might be a good time to buy. Yields fluctuate from day to day (you can find the latest at www.bondsonline.com), but recently some maturities of high-quality municipal bonds, which are tax-exempt, have been offering higher yields than similar maturity Treasuries, which are taxable. That almost never happens and is a reflection of fear in the markets.

"This is irrational," said Chip Norton, Lydian Trust Co.'s managing director of fixed income, who was in the Tampa Bay area recently speaking to clients. "It's not like we're having headlines saying the state of Florida is going into default. It presents an opportunity for investors to get very good absolute and relative yields in the municipal market."

Norton said municipal bonds have much lower default rates than corporate bonds with the same ratings. "The insurers themselves are substantially more likely to default than the vast majority of the municipal credits they protect."

Municipal bond shopping?

Investors will find yields are lowest for the most secure bonds, which are general obligation bonds and water and sewer revenue bonds. Higher yields are available by taking more risk with bond financing projects such as hospitals, health care facilities and airports. In addition, there's an extra yield reward for buying bonds subject to the alternative minimum tax. Low-rated and unrated bonds carry the highest risk of default and are for money you can afford to lose.

Be vigilant with Florida bonds

Even though a bond is a long-term investment, it's not something investors can buy and forget. In Florida, we'll be watching how well local governments weather the economic downturn and property tax cuts. If you buy a bond, you want to be sure the issuer will be able to make those interest payments and give you your money back when the bond comes due.

[Last modified February 8, 2008, 21:46:59]