Lack of bond insurance adds to fear among muni investors, but market still has value, DWS says

By Sheri Kasprzak

New York, Jan. 26 - Municipals have faced a lot of scrutiny over the past couple of years, particularly among frightened retail investors, and the absence of triple-A rated bond insurance might be adding to that fear, said DWS Investments' Phil Condon, head of municipal bond portfolio management, and Ashton Goodfield, head of municipal bond trading.

"The idea that half the market isn't insured anymore is one reason we're seeing some concern about the market right now," Goodfield said during Wednesday's DWS conference call on fear, weakness and opportunity in the municipal market.

"Seventy percent of buyers in the market are retail investors either buying their own bonds or purchasing bonds through funds. It can be a volatile market when there are a lot of people in the market who don't necessarily understand all the credit factors we as professionals understand."

Goodfield said that talk in the media about mass defaults and bankruptcies has led some retail investors to flee the market without employing the research needed to ensure investments are safe and secure.

She pointed out that there are over 50,000 issuers in the market, most of which are fine. One percent of those issuers account for 64% of the total par amount of debt outstanding.

"Most of the muni bonds that come to market are very small, roughly $30 million in size. The vast majority of the par amount in the market is a small amount of issuers," she said.

She noted that these large issuers that make up the majority of the debt issued have a greater need to access the capital markets and therefore are less likely to resort to defaults or bankruptcies.

Speaking about the market as a whole, Condon said municipals have suffered record outflows, spurred mostly by fears over rising Treasury yields, stagnating tax rates and other economic pressures on state and local governments.

He also noted that comments from independent banking analyst Meredith Whitney that there will be widespread defaults and bankruptcies in 2011 came when the market was already vulnerable.

"We all have the same concerns she has, and we have for quite some time," he said. "Where we disagree is that there will be widespread defaults and bankruptcies."

Condon said that rather than the doom-and-gloom pictures presented by the media, he's actually seen governments facing up to their responsibilities. Debt, he noted, is a very small problem for state and local governments.

"Even if governments had no debt, they would still have a problem," he said.

There has been a shift in the market, Condon and Goodfield said. General obligation bonds, which have been traditionally considered the safest municipal investment because they're linked to taxing power, are being questioned more.

"We've seen some G.O.s become cheaper and cheaper," Condon said.

"We're seeing some investors who might not otherwise invest in G.O.s. Typically, a mutual fund might have had very little exposure to G.O.s. Now they would probably have a little more because of the opportunity."

The bottom line, Condon said, is that municipals are cheap.

"Yields got as low as they've been since the late 60s at the long end of the market," he said.

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