As Nassau County, N.Y., prepared for its first debt sale since 2000, it originally anticipated selling insured auction-rate bonds. But questions about the financial outlook for some bond insurance companies prompted the county last month to instead issue $75 million of variable-rate general obligation bonds backed by a letter of credit. “We did change our plans last month because of the insurance uncertainty,” said county debt manager Jeff Nogid. “The auction-rate market was showing some signs of unease, and I think still shows signs of uncertainty.” Nassau County isn’t the only issuer in New York — or the country for that matter — taking a second look at the need for bond insurance. Several high-grade issuers recently have chosen to go market with only their underlying ratings. And while observers say lower-rated issuers still see a need for bond insurance, they are likely to be more selective about which companies they do business with. Rating downgrades for Radian Asset Assurance and ACA Financial Guaranty Corp. stemming from the subprime mortgage meltdown, and the ongoing review of the major triple A bond insurers — such as MBIA Insurance Corp. and Ambac Assurance Corp. — have created tumult in the municipal bond market when it comes to the question of credit enhancement. Market participants say they no longer know what the value of insurance is. “Bottom line is, the whole concept of insurance has been damaged,” one banker said. “It’s very hard for those insurers who are on credit watch.” If December is any indicator, underwriters and issuers are now less likely to insure a bond sale. Insurance penetration for competitive deals in New York in December was 28% compared with 86.3% in December 2006, according to Thomson Financial. On negotiated deals just 3.6% carried insurance in the last month of 2007 compared with 35.1% in December 2006, according to Thomson. Dutchess County competitively sold $27 million of bonds last month without insurance. It was the first bond sale by the county since 2004 that did not have at least some insured maturities, according to Thomson. Raymond Hart of Public Finance Associates Inc. serves as Dutchess County’s financial adviser. He wasn’t completely surprised that the winning bidder, Piper Jaffray & Co., chose not to insure the bonds. “I was kind of waiting to see what would happen,” Hart said. “It’s definitely a case of [bond insurance] not being cost-effective for the better credits.” Moody’s Investors Service rates the county Aa2. Standard & Poor’s and Fitch Ratings don’t rate the credit. Hart said the test is whether lower-rated credits will continue to use bond insurance. “Do you pay it and then if they get downgraded you get diminution of your own investments?” he said. “Maybe it’s better to go with the underlying credit. For the double-A or the triple-A, obviously that probably makes sense. For the A and certainly the Baa, even a double-A insured credit is probably better than an underlying Baa.” Bankers and financial advisers say they are being more cautious in deciding whether to use insurance or advise their clients to do so. The trend has benefitted Financial Security Assurance Inc. and Assured Guaranty Corp., as analysts have said those insurers appear to be the least affected by exposure to securities tied to subprime mortgages. “We’re trying to be a little bit pickier about who insures deals,” said Angela Rodell, senior vice president at First Southwest Co. “If you have an issuer that has a lot of one insurer, say a lot of Ambac or MBIA, maybe we don’t open the bid up to them and try to get one of the others that looks a little bit better.” First Southwest’s clients are seeing concerns about insurance issue arise for issuers, not just on bonds but also on insured interest rate swaps and guaranteed investment contracts. “You’re seeing the concern come not just on the new-issue side and should we insure bonds, but also in terms of looking at existing portfolios and asking, 'What is my exposure to different insurance companies?’ and 'What happens if all these negatives outlooks turn into actual downgrades and what does that trigger? Does it trigger a termination event or a collateral posting?” Rodell said. Insurers says the news that investor Warren Buffett plans to enter the municipal bond insurance market affirms that there is still a need for it. “We see this as another confirmation of the strong opportunities for triple-A rated bond insurers in the U.S. municipal market and a validation of the business model,” FSA managing director of municipal finance Scott Richbourg said in an e-mail. “There are enormous infrastructure needs, and we, as well as the other industry members, can be expected to play a big role in getting those financings done. We welcome Warren Buffett’s credit and pricing discipline to the market.” Lawrence Turtle, president of New York Municipal Advisors Corp., said decisions whether to insure deals will still need to be done on a case-by-case basis. “There are certain credits that are going to need insurance, particularly in the lower end of the investment grade, but then we have to take a very close look at it if it’s needed in the other categories,” he said. “The key thing is we’ve got to be very careful to see if it’s cost-effective.”As Nassau County readies a $125 million competitive bond sale next week, it’s going to several insurers to get itself prequalified in case the winning bidder wants to use insurance. It’s unclear, however, whether buying insurance will make economic sense for the underwriter this time around, Nogid said. “Originally, we thought the bidder would want insurance,” he said. “We’re thinking now that the bidders may not want insurance. Depending on the prices, we may be right on the cusp of what is economically feasible to buy insurance or not buy insurance. But it’s kind of hard to say — we’re going to be one of the first municipalities in the market in the year.” Public Financial Management is the financial adviser on the deal and Orrick Herrington & Suttcliffe LLP is bond counsel. The bonds will be used to finance Nassau’s ongoing capital program and likely have maturities up to 10 years or more. Standard & Poor’s assigns its single-A rating with stable outlook to the county and Moody’s assigns its A2 rating with stable outlook. Fitch rates Nassau A-plus. On the investment side, a credit’s underlying rating has taken on new importance. “There’s a much higher attention being paid now to the underlying credit, simply because the fate of the insurers is uncertain,” said Joe Darcy, senior portfolio manager at Dreyfus Corp. “I’ve thought for some time if you’re looking solely at insurance for comfort you’re missing a more telling part of the picture. You always have to be cognizant of the credit and liquidity characteristics of the underlying issuer, as opposed to focus on the monoline overlay that wraps it.” Investor skittishness is evident in auction-rate bond market, which saw spreads spike in November and early December, though they’ve come down somewhat since then, according to several issuers. New York’s Metropolitan Transportation Authority saw interest rates on its portfolio of auction-rate bonds spike in late November by as much as 85 basis points, but by mid-December those rates had fallen. New York City deputy budget director Alan Anders said some of the city’s auction-rate debt with weekly resets spiked by as much as 55 basis points around the same time period, but that while officials were closely monitoring the situation they weren’t looking to convert auction-rate debt at this point. “As we followed it in the successive weeks we recovered over half of the increase,” he said. The Port Authority of New York and New Jersey also saw its spreads widen on two series of bonds sold in auction-rate mode last year by 130 basis points. “We did see rates start to spike in November in the later part and the early part of December, but the most recent that we had starting this year, the rates have come back down,” Port Authority treasurer Anne Marie Mulligan said. “Everyone is seeing changes in their rates as a result of the liquidity crunch caused by the bond insurers. Everybody’s experiencing it.” The Long Island Power Authority is looking at options for dealing with the rate fluctuations it’s seen in its $944 million portfolio of debt issued in auction-rate mode. Chief financial officer Elizabeth McCarthy said that spreads widened but then contracted. She declined to provide specific data, saying LIPA was in the process of compiling it.

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