Municipal Bond Forum

While we are optimistic that both Ambac and MBIA will likely survive the current mortgage crisis, we are in no way confident as to what the future may hold. The municipal bond side of both companies is performing well, as they always have. The problem is rooted in their exposure to the sub-prime and Collateralized Debt Obligation mortgage market. The rating agencies, who are in a position to have detailed knowledge of these exposures, have zig zagged between assurances that the insurers would not be touched by the mortgage crisis to outright downgrades of the insurers just a few months later. The downgrades resulted in collateral calls and further loss of credibility and stock value for both MBIA and Ambac. At this point, both insurers carry ratings in the “AA” or “A” categories with either a negative watch or negative outlook. The future of both companies will depend heavily on how much of their mortgage exposure actually results in real dollar losses and where that leaves their capital levels.

The rating agencies base ratings of bond insurers on three main factors: capital levels, quality of insured portfolios and business prospects. Currently, capital levels (incorporating expected losses) are below that needed for an “AAA” level rating, although they are adequate to meet anticipated claims. Business prospects are rated as poor since little new business is being underwritten without the “AAA” ratings issuers have come to expect.

 Without regaining their prior status as “AAA” level bond insurers, both Ambac and MBIA are unlikely to remain as major players in the new business side of the bond insurance industry.  They could remain solvent with their insurance in force in what the industry calls “run off” mode. This is the likely scenario we see, but don't rule out either a better or worse eventual outcome. In any case, their portfolios continue to perform well since the vast majority of Ambac and MBIA bonds are of high quality on their own and continue to meet their debt service obligations as they always have.

The vast majority of Texas school districts do carry the Permanent School Fund (PSF) guarantee, but not all. The fund, created by the Texas Legislature in 1854 to assist in the funding of public education, has been guaranteeing school district debt since 1985. Since then, approximately 2,600 bond issues worth $80.2 billion have been sold with PSF support.

Issues may not carry PSF backing for several reasons. The fund's size and present book value limit capacity to guarantee new debt. Based on a complicated formula, the maximum allowable debt stands today at $56.3 billion. The "Bond Buyer," a trade publication, reported recently that only $371.7 million of capacity remained as of May 31, 2008. The Texas Legislature has passed, and the governor signed, a bill to raise the capacity, but it has yet to be approved by the IRS, which monitors the tax implications of programs like the PSF.
Because of program capacity limits, the Texas Education Agency, which administers the PSF program, has instituted requirements for participation. Districts must have their bond issues approved by referendum, be financially sound, and meet other standards as well.

Demand remains high for PSF support. Over $5.3 billion has been approved or awaiting approval this year, and much of this amount may have to be sold either without the PSF guarantee, or with private bond insurance, unless capacity levels are eased.

The popularity of the PSF program, its financial strength, and “AAA” rating, have combined to provide a high quality investment opportunity for bond purchasers over the years.

Actually, all bond funds are not alike, and can differ in a variety of ways. If you are confident that the two funds to which you refer have the same investment objectives and performance, then we know of no reason not to opt for the fund with lower fees.