Market Muted in ACA Drop

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While most of the damage has already occurred, the municipal market is approaching Standard & Poor’s recent news on monoline bond insurers with a wait-and-see approach. Standard & Poor’s announced that ACA Financial Guaranty Corp. would be downgraded to triple-C from single-A. It also changed the outlook on Ambac Assurance Corp., MBIA Insurance Corp., and XL Capital Assurance Inc., all confirmed triple-A insurers, to negative. The Financial Guaranty Insurance Co. was placed on negative credit watch. In the midst of all this news, one could look for a dramatic weakening of the market, but this was not the case. The Municipal Market Data triple-A yield curve was down one basis point on the short end and four basis points on the long end. The Municipal Market Advisors consensus was one to three basis points firmer in yesterday’s trading session. The general consensus for this was that the market already priced in these potential changes.“It was not a surprise that this happened,” said Tom Spalding, senior investment officer at Nuveen Investments. “There has been news of this for some time now. Now the market is waiting to see where this goes, so, for example, you haven’t seen any trades on ACA-insured bonds, and as far as I know there aren’t any large ACA positions that are an effect of distress.” ACA’s woes have been known for some time. In early November, Standard & Poor’s placed the company’s rating on negative credit watch, only to be followed by ACA saying that a downgrade would drag the company down. In early December, the New York Stock Exchange began proceeding to de-list ACA, which occurred last week.

Bob Millikan, portfolio manager at BB&T Asset Management agreed that he saw no ACA paper trading.“I only saw one person trying to get out of some ACA paper, and they did not succeed,” he said. “People have been getting out of ACA paper for the past couple of weeks, so when this happened, the moves had mostly been done already. It is just really difficult to gauge right now where this thing settles out, we will probably get a better sense when things pick up at the start of the new year.” News on the triple-A insured companies having their outlook or credit watch changed to negative appears to have had the same response in the market. “The thing is, [bonds insured by] these triple-A insurers have been trading roughly in the weak double-A category for some time now,” Spalding said. “So there was little to no reaction. That being said, I think the market is anticipating that these companies want to keep their triple-A rating and will do what it takes to keep it.” Later in the day yesterday, Fitch Ratings made an announcement in response to issuer questioning, that if a municipality’s rating is higher than the downgraded insurer, that the secondary market should value the underlying rating over the insured one. So, if you are rated A-minus and insured by ACA, the A-minus stands, and not the CCC. Rick Calhoun, first vice president of sales and trading at Crews & Associates, agreed that this is the case for the most part. “You have got to look at underlying ratings now,” he said. “In the case of ACA, one will keep the underlying, but it will still trade a little bit weaker than the underlying because no matter how you look at it, it has been tainted somewhat.” Secondary market trading of ACA-insured bonds was extremely limited. Calhoun pointed to Reeves County, Tex., which sold roughly $12 million of certificates of participation in April 2005. The bonds mature in 2014. Rated triple-B by Standard & Poor’s, the county opted for ACA insurance. Calhoun said the bonds have steadily deteriorated in price, from a high in September of $101.50 to a trade last Friday that was $95.50. “We’ve been following this bond for some time now, and we’ve tracked how it has moved,” Calhoun said. “It didn’t trade today but you would be working a miracle to get a bid on that bond today and if you did, it would be substantially lower then what we’ve seen recently.” Interactive Data Corp. priced this CUSIP at $93.97 at the end of trading Tuesday. One footnote Millikan also pointed out was that in many cases now, ACA bonds are trading worse than nonrated ones. “Hey, when you look at it this way, ACA is rated non-investment grade, but with a nonrated CUSIP, you just don’t know,” he said. “With that in mind, in many instances you could have nonrated bonds trade better then ACA-insured going forward.”

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