There is a Silver Lining In The Cloud Over ACA

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz has earned its reputation by identifying municipal bonds that possess solid fundamentals, but are selling at a discount to their intrinsic value. The usual culprit is investor overreaction to negative publicity.

Eventually fundamentals carry the day, resulting in better than market returns for our investors. We are currently monitoring another situation which we feel represents exceptional value in today’s market.

ACA Financial Guaranty is a financial insurance company whose issues have been managed by many of the largest, strongest and most respected Wall Street firms. Last week, Standard & Poorâs placed ACA on “negative credit watch,” stating that ACA’s capitalization levels were below those required for a single-A rated insurer.

This was not a new story. The company previously announced that it intended to raise $45 million in additional capital. What is new is the S & P deadline of February 1, 2001 to raise this new capital or face a rating downgrade.

Michael Satz, president of ACA, said it was an unfortunate episode for the company, but would not be detrimental to its future success. He announced that ACA had already hired Bank of America Securities to help it raise the $45 million in equity to bolster its hard capital base, which would be the final step in the company’s three-step capitalization plan. Its previous actions were successfully completed earlier this year. Recommendation

S & Ps announcement has negatively effected the market value of these bonds, but at the same time it has created an unusual opportunity for bond investors. Consider the following:

  1. Until this situation is resolved, investors can purchase ACA bonds at yields that are considerably higher than yields on other similarly secured bonds – as much as 100 basis points higher.
  2. The negative S & P report is not related to the company’s ability to pay claims on its portfolio of insured bonds. In fact, S & P acknowledged that “the credit profile of ACA’s book of business remains acceptable.”
  3. Approximately 70% of ACA’s portfolio of insured debt is investment grade or better.


Investors must be aware that market conditions for these securities could be volatile and these bonds should not be purchased as a trading vehicle.

If ACA is downgraded, many institutions will be required by law to sell these securities, which could keep the market for these bonds under pressure for some time.

These bonds should be purchased by “buy and hold” investors only.

We will continue to keep you informed of any developments regarding this situation

James A. Klotz is the President of FMSbonds, Inc.
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Jan 15, 2001

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.