With ongoing problems in the bond insurance market, large institutional investors say they continue to find value on A-rated bonds - with insurance - in the secondary market now that spreads between generic triple-A and single-A paper have widened by approximately 30 basis points versus where they were before the subprime mortgage crisis unfolded over eight months ago.

The price deterioration is enabling investors to buy A-rated underlying paper with insurance at spreads not recently or readily available in the credit markets, said Phil Condon, managing director at Deutsche Asset Management in Boston.

"It may still say triple-A on it, but people are still treating it as if it's a single-A" without the insurance because of the extreme focus on underlying ratings and the overall uncertainty of the future of the bond insurance industry, Condon noted.

Back in July before the subprime mortgage collapse, spreads between natural triple-A rated bonds and single-A bonds were between 20 and 25 basis points, according to Condon.

"That was a long-standing spread," Condon said. "The spreads have not been this wide for a long time."

On Wednesday, he said that the spread between the generic triple-A scale and A-rated scale published by Municipal Market Data was 52 basis points in 10 years and 51 basis points in 30 years.

"The dislocation started when people got nervous in August and credit spreads widened. The first thing to move was the uninsured bonds, and now we have a situation where the insured bonds have gotten cheaper," Condon said.

Others say there is a range to that cheapness, but overall, they say investors are realizing an incentive to buy the A-rated paper backed by insurers affected by the current deterioration of the subprime fallout.

Different spreads are available for different guarantors whose insurance credit strength has been weakened as a result of being downgraded or put on watch for having exposure to subprime mortgage products, managers noted.

"The market is discounting the value of insurance on triple-A insurers that are having problems," Condon said. "There is a little more interest in buying the weak insurers - but the insurance is still being priced as if it has little value. An A-rated bond with [Financial Guaranty Insurance Co.] insurance is trading close to where it would be without insurance."

Of all the insurers, Financial Security Assurance - which earlier this week announced a $500 million capital infusion from its parent - is trading at the tightest spreads, he pointed out.

Steve Galiani, managing director at Wells Capital Management in San Francisco, said the range of spreads is apparent. He pointed to stronger bonds, like those wrapped with FSA insurance, trading as tight as 20 to 25 above the triple-A generic GO scale, and weaker credits, like FGIC-insured bonds, trading closer to 50 basis points higher.

Earlier this week, for instance, Galiani observed a trade on a California lease revenue bond from a well-known issuer that was FGIC-insured with double-A underlying ratings that traded at 48 basis points over the triple-A generic scale published by MMD. The bond was originally offered at 44 basis points over the MMD earlier in the day.

He said if the bonds had been insured by FSA, they would have traded at only 20 to 25 basis points higher than the MMD scale. Meanwhile, prior to eight months ago, the same trade on bonds guaranteed by either insurer would have taken place at only 10 to 15 basis points over the triple-A MMD scale, Galiani pointed out.

"That shows you the uncertainty in the market," he said. "Even though FSA is a firm triple-A, and they announced a capital infusion, it is still trading wider by about 10 basis points than they would have traded in the past."

"The [triple-A] ratings were so powerful ... what created a commodity was the nine As, and that's gone," Galiani said. "Now, the market has learned that there is more risk and variability in ratings."

Galiani himself is dabbling in the secondary market, seeking out bonds from the weaker insurers.

"We have been looking for opportunities, and we have found one or two, but not as many as we would have liked," he said.

"I am more of a buyer than a seller," he said. "We had one or two sales, but those were made as an adjustment to relative duration and where am I going to get the best value to sell to accomplish other goals in the funds."

Galiani manages some private accounts, common trust funds and mutual fund portfolios that consist of four California, one Oregon, and two Colorado funds totaling over $1.75 billion.

He said the Wells Capital municipal team has traditionally promoted diversification as an asset management tool, and one way he employs that strategy is to maintain insurer diversification in the funds by avoid having more than 12% of assets insured by one single insurer.

"We were well positioned with regard to the insurers" before the subprime mortgage fall-out, he said.

Comparing other major debacles in the municipal market in recent years - such as yield burning, bankruptcies like Orange County, Calif., and other federal probes - Galiani said the bond insurance dilemma has produced little in the way of any potential ethical violations, but "there have been more mistakes."

"In many ways it's bigger because it isn't just someone doing something with certain ramifications - these are events that have realigned and reevaluated the market."

"Eventually, you will see people appreciate the value of insurance - depending on how much they want to pay for it - but it will take a while for that level of confidence" to resurface, Galiani said. "Spreads might change a little bit, but eventually they will stabilize and you will see established spreads." q

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