Several dealers commented that they are taking the growth prospect of municipal bond-backed CBOs seriously, although resource allocation to the product has been mixed.

A major driver for the muni CBOs is going to be the massive amounts of unrated muni-debt which investors want to move off balance sheet and gaining an arbitrage is encouraging, since these bonds have considerable spread, said Chris Moriarty, a director at Standard & Poor's.

The first round of muni CBOs are expected to be backed by affordable multi-family housing revenue bonds issued by state or local issuers, like Charter MAC's inaugural issue. S&P said the housing bonds generally are considered "hearty" collateral with decent recoveries and it is possible to get a securitization up to "AAA" unwrapped with these bonds, said the official.

S&P expects to see both arbitrage and balance sheet muni-backed deals in the near future.

"Many bank portfolios have large un-rated muni-bond portfolios, and we expect to see those assets put in a CBO, and the issuer taking back some of the rated tranches, which would improve their regulatory capital standing," said Moriarty.

S&P said they can shadow rate municipal portfolios using a statistical approach, granted the portfolio has enough mass, in the 200 bond and over range.

Moriarty is quick to point out that clients should not be scared away by cost of the shadow ratings on the unrated municipal bonds, as the statistical approach is relatively inexpensive, given that muni-bonds are fairly uniform.

"We don't want people to think we're going to charge $5,000 or $10,000 per bond," Moriarty said. "We have the know-how to shadow rate these in an efficient manner."

Last week's Charter

Charter MAC, which in 1998 issued the first visible CDO backed by municipal debt called Charter MAC Low Floater Certificate Trust 1, issued two new series of certificates totaling $75 million via Goldman Sachs last week. The two series of MBIA-wrapped certificates are secured by tax-exempt multi-family affordable housing revenue bonds. Both series have legal maturities of five-years.

The $45 million California (CAL-2) Series (AAA/A-1) is backed by a securitization of six tax exempt multi-family bonds issued in California ($48 million par value) and yields 2.10% over an undisclosed floating-rate municipal index. The $30 million National (NAT-2) Series is backed by a securitization of four tax-exempt bonds issued by four states (par value $48 million) and yields 2.35% over a floating rate municipal bond index.

The new series brings Charter MAC's Trust 1 muni-CBO issuance up to $350 million and the Trust's MBIA triple-A insurance policy is up to $500 million, which provides long-term credit enhancement for the Trust. In addition, the Trust has a $350 million liquidity facility from a consortia of A-1+/A-1 rated banks. The facility provides support to the certificates in the event of a failure to remarket the certificates or pay debt service on a timely basis.

The first-loss piece on Charter MAC has been absorbed by the firm's affiliates, sources said.

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