By Kenneth N. Gilpin

Published: March 8, 1993

INVESTORS looking to capitalize on bullish conditions in the tax-exempt municipal bond market might consider four publicly traded companies that insure and reinsure bonds for states and municipalities.

Two of the companies, Ambac Inc. and MBIA Inc. insure municipal bonds. Capital Re and Enhance Financial Services Group Inc. are in the reinsurance business, which assumes part of the insurer’s risk in return for some of the premium paid by the insured.

Wall Street analysts say they like all four companies, in large part because trends in the municipal bond business remain so favorable.

Because of the further decline in interest rates since January, new-issue volume in the municipal bond market is up about 10 percent from where it was a year ago, to around $40 billion, according to figures from the Securities Data Corporation.

Investors worried about credit quality in the tax-exempt market have compelled issuers to increase their use of the insurance companies. Of the new bonds sold so far this year, around $15 billion carry insurance, up nearly 50 percent from the same period last year.

Stock investors have not been caught unaware, and prices of all four companies have moved sharply higher over the last few months. But analysts said that compared with the broader market’s price/earnings valuations, these stocks still have room to rise.

All the companies in this sector will benefit from positive macro trends, and continued declining interest rates will be good for the industry, said Margaret M. Alexandre, an equity analyst at Salomon Brothers.

Joan S. Solotar, a research analyst at Donaldson, Lufkin Jenrette, said the group would outperform the rest of the market. These stocks are still selling at large discounts to the market, she said.

Prospects for insurers would improve even more if interest rates were to decline by 30 more basis points or so, Ms. Alexandre said.

A drop of that magnitude would be likely to bring another round of refinancings by issuers, events that are particularly lucrative for bond insurers.

Insurers collect 100 percent of their premiums up front, Ms. Alexandre said. That means on a bond that was only issued five years ago and then gets refinanced, they can amortize 25 years of premiums into earnings, in addition to collecting another premium on the new bond. Refundings are great for the bottom line.

Currently, Ms. Solotar rates MBIA as a buy, and calls Enhanced Financial very attractive.

On the New York Stock Exchange, MBIA shares closed at $66, down $1.25, on Friday, and Enhanced Financial’s stock closed at $21.75, down 12.5 cents. Ambac closed at $46.75, down 25 cents, and Capital Re at $24.625, down 50 cents.

Although industry trends remain positive and will improve even more if interest rates continue their downward course, the threat that an issuer might default on insured bonds remains. That risk adds an element of volatility to the stocks. But analysts said the threat is overblown, and that investors are learning to live with it.

Michael Smith, an analyst at Lehman Brothers, noted that when Philadelphia was on the brink of bankruptcy in 1990, MBIA shares plummeted by 50 percent because it had insured some Philadelphia bonds. In 1991, when Bridgeport, Conn. declared bankruptcy, MBIA stock fell by 20 percent. And more recently, when a voter revolt in Brevard County, Fla. threatened to block financing on MBIA-insured certificates of participation issued by the county, MBIA’s stock fell by 10 percent.

Each time the stock came back, Mr. Smith said. The real strength behind municipal bond insurers is that ultimately you can’t have a default, because it is in everybody’s best interest to avoid it. And if you have a default there has to be a workout, one in which the insurer is going to participate.