Buying tax-exempt single-family housing bonds can be like walking through a minefield, but if investors sidestep the dangerous call provisions, the trip can be well worth it, according to a study by John Nuveen & Co.

Peter Fugiel, vice president of research at Nuveen and author of the report, said the municipal market is afraid to price single-family bonds because of the intense research required. As a result, the bonds can be priced significantly below -- and above -- their true value.

The necessary research must focus on call activity and paydown rates, not issuer creditworthiness, according to Mr. Fugiel. The most explosive risk is that an investor will buy a bond at a premium, only to have it called in the near future, he said.

"The [retail] investor thinks that a double-A rating protects him, bu he's actually getting totally mauled," Mr. Fugiel said in an interview.

The mauling is an outgrowth of paydown activity. With housing bonds, certain issuing agencies can engage in "cross-calls" and "designations" when applying early mortgage payments. These methods allow the agency to pay off one borrowing -- most often the outstanding bonds with the highest coupons -- with the cash flows of an entirely different bond issue.

Mr. Fugiel's report, "Paydown Rates in the Municipal Market," cites the dramatic example of the Pennsylvania Housing Finance Agency's Series F bonds, sold in 1984. The 5/8% securities, thanks to cross-calls, were all redeemed only six years after they were issued.

"The banking techniques are all lined up on the side of the issuer," Mr. Fugiel said. "The retail investor has to be really paranoid about these public bodies. They should not assume the tax-exempt issuers are merely conduits."

Information on cross-calling and other paydown practices is available to indentures, he added, but retail buyers have to be very sophisticated to be sensitive to the effects. "Unless you understand where your bond is in relation to all the others, you don't know what you're getting," he said.

Still, looking at the entire market, the paydown experience in the tax-exempt single-family sector is superior to the taxable housing bond sector, Mr. Fugiel said.

His study analyzed 100 mortgage pools from every region of the country and found a special paydown rate -- the percentage of oustanding bonds that will be paid off annually -- of 4.46%. The Public Securities Association's benchmark paydown rate for taxable bonds, meanwhile, is 6%, so an investor's call risk is greater when buying Federal National Mortgage Association bonds, for example, than when buying municipals.

"That's because our market's home buyers are lower-income, first-time mortgagers" who are unlikely to sell their homes or pay off their loans soon, Mr. Fugiel said. "In conventional pools, the majority of buyers are higher-income and second-time purchasers."

While cross-calling made the Pennsylvania Series F an onerous investment, a refinement of the method -- designation -- can create "protected" maturities by singling out the first bonds to go, he said. All other securities issued under the same indenture, regardless of interest rate, are given longer lives by the early death of the designated series.

A prime example is the Texas Housing Agency's 1983 Series A. If investors bought the 2009 maturity, they were given about two years of extra protection by the designation that the 2000 maturity would be the first to get the paydown hook. Again, the information was included in the indenture.

"The bankers will fashion call orders because of the way the yield curves," Mr. Fugiel explained. "And the long buyers might pick up extra income for reasons totally unrelated to the structuring of the deal. The bonds may not get called for eight years and the 104.5 price might really be worth 109.

"But because of the uncertainty surrounding single-family bonds and the higher coupon, the price doesn't go up as high as the bond warrants," he said.

Special economic circumstances also can profoundly affect the housing investor by affecting the housing agency's disposition of mortgage paydowns, according to the Nuveen report. Buyers of the Alaska Housing Finance Corp.'s 1980 Second Series .20% bonds, for example, benefited throughout the 1980s from an unusual cost-of-funds situation.

Essentially, prepayments were recycled as new loans, rather than used to pay down the issue, because the money coming from the 1980 mortgage paydowns remained "cheap enough" for the agency to continue to use, the report says.

The single-family market's tricky footing is evident on the flip side of the coin. An expensive cost-of-funds relationship was one factor that led the Alaska agency to call nearly two-thirds of its 1984 First Series bonds. Since the state subsidized the issue through a guarantee, it ended up costing Alaska money to keep the issue oustanding.

Consequently, the agency designed a refinancing that simultaneously gave home owners a lower monthly mortgage payment and called the bonds out from under investors. "There's no [agency] more ambitious than Alaska," Mr. Fugiel said. "A good dose of paranota will serve [investors] well here because a lot of these guys are pretty clever."

Some aspects of the housing market may simply be too arcane for an investor to fathom. Sifting through the California Housing Finance Agency's indentures, the sharpeyed bond buyer would come across detailed cross-call language and reasonably conclude that the highest coupon outstanding is the next to go.

But no so. Due to tax law considerations, the California agency already has earned its maximum allowable spread. Taking paydowns from lower-interest mortgages and applying them to higher interest loans, therefore, would result in a wider spread and the agency would have to rebate the proceeds to the Treasury.

"The problem in cross-calling is [when] you are already earning your maximum allowable spread," said Ken Carlson, finance officer at the agency. "If you take revenue from a lower interest deal and call high-interest bonds," the spread widens.

The maximum allowable spread between mortgages -- assets -- and tax-exempt bonds -- liabilities -- is 1 1/8%, according to Mr. Carlson. Housing agencies are allowed this margin, he explained, so they can pay operating costs.

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