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Q

I am heavily invested in Ohio tax-free municipal bonds. My huge open-ended bond fund went from being 100% “AAA” insured to 80% “AAA” insured, but because of recent negative news surrounding bond insurers, my fund will suffer yet another hit. How safe are these investments today, without the insurance, given the economic outlook for my state?

A

James A. Klotz responds:

Although the bond insurance industry has seen its financial strength ratings either lowered or threatened to be lowered, this is not a reflection on the underlying bond issues and their ability to meet debt service. We can well understand your concerns, living in Ohio, a hard-hit area economically. However, while Ohio is experiencing economic displacement, its municipal credit quality remains strong. The economy is an important determinant of credit quality, but not the only factor that is taken into account. The state just had its rating reviewed on July 22, 2008, by Standard & Poor’s with a very strong  “AA+” rating assigned to state obligations. In their report S&P stated the following:
“The ‘AA+’ rating on Ohio reflects the state’s:
·    Long history of strong and disciplined financial management, as shown by recent budget adjustments;
·    Improved budget stabilization reserve levels through fiscal 2007 year-end;
·    Biennial budget for 2008-2009, which continues tax reform initiatives but relies on substantial cost-containment, as revenue growth remains tempered by the state’s below-average economic performance;
·    Vast, broad, and diverse economic base, which is anchored by manufacturing and includes several regional centers and corporate headquarters, in addition to expanding service sectors; and
·    Moderate debt levels, with rapid amortization and a conservatively managed capital and debt program.”
Obligations of cities and towns and other governmental issues are no doubt strong as well since the default rate for such bonds, even in states much weaker than Ohio, is minimal.

Rest assured, the crisis affecting bond insurance is not related to the performance of their underlying municipal bond portfolios. Those are performing as well as ever. It is the mortgage backed security industry exposure that is fundamentally at fault for the bond insurer headaches we are all experiencing.