CA Municipal Bonds

[Ready]

I see advertisements in the LA Times every week for individual CA Municipal bonds from a securities broker. Today's ad is from "Southwest Securities", Welcome to SWS Group, Inc.. These bonds are state and federal tax free for CA residents.

They are offering two different bonds:

1) Lake Elsinore, CA USD CFD Special Tax Bonds. Coupon 5.4%, maturing 9/1/35. YTM 5.40%. Priced at 100, callable on 3/1/14 @102. $25K minimum.

2) LA Public Works Rev Bonds, coupon 5.00%, maturing 8/1/42, YTM 5.00%, priced at $100. Callable 8/1/22 @100. $25K minimum.

So at first glance, it appears these bonds are offering at least 5% returns. Yet I know this seems to good to be true, so what am I missing? I have to admit that even after reading an entire book on how to buy bonds, I still struggle with the idea of buying individual bonds, as I don't feel I'm knowledgeable enough on how to value them and assess their risk to be comfortable in doing so.

Can someone help me to decipher whether these are really paying 5%, or am I paying a premium on the NAV that effectively reduces their yield?

The Lake Elsinore bonds are not rated, and the Public Works bonds are AA-.

 

[Gatordoc50]

They are both paying 5+ percent. If you hold to maturity and they don't default that is what you will receive.

 

[2B]

If they were any good, there wouldn't be ads in the LA times. The ads are to try to drum up interest in a bond issue that can't get enough interest in the normal municipal bond market. Even at the high rates, there weren't enough buyers to soak up the issue. They need unsophisticated investors to buy these dogs.

You didn't specify any details on the bonds but I suspect the repayments are based on the projects generating enough revenue to pay the P&I and eventually the redemption. It's possible that the these could be "full faith and credit" but the underlying stability of the issuer is in doubt.

I wouldn't trust the bond ratings in the current environment. FF&C have tradionally been given high ratings from the rating agencies. Detroit is lumping their FF&C bonds in with revenue bonds and public pensions.

I remember similar ads being run many years ago in Seattle for the Washington State Nuke Plants. They were revenue bonds to be paid for out of the electrical power sales. The interest rates were shown at about double the going rate. Several weeks later all of the nuke plants were cancelled. All the bond issues went into default. Nobody got a penny back. I almost bought some.

 

[Gatordoc50]

The revenue bonds may be able to pay interest and return principal but default nonetheless. The city may decide that others deserve your principal more than you.

 

[wolf]

I'm a resident of California. California has a lot of "unfunded" debt.

Would not touch any California bond, unless it was "General Obligation"
of the State of California.

(not any city or county). Think, Detroit, Stockton Calif, etc).

5% return does not justify the risk you are taking.

 

[FIREd]

I own some CA muni bonds via a Vanguard mutual fund (VCADX). I don't think I am qualified to do an in-depth analysis of individual bonds so I let the good folks at Vanguard do the research for me.

 

[haha]

The revenue bonds may be able to pay interest and return principal but default nonetheless. The city may decide that others deserve your principal more than you.

This is apparently an issue that remains to be determined right now in the Detroit bankruptcy. Some water supply bond, which also supplies some well to do suburban areas is in fine shape but Kevin Orr is attempting to divert some of its revenues to general city of Detroit obligations.

We are finding out a lot about just how strong covenants are when public worker unions want the money.(Or in another recent bk, when the UAW wants the money!)

Overall, I think I am shying away from any even slightly questionable issue when their are powerful unions involved.

Ha

 

[Ready]

Thanks for the replies so far. I understand that there is risk in almost any investment, but hasn't the default rate on municipal bonds overall been quite low? And doesn't the yield seem too high for an investment that historically has had a low default rate?

Also, couldn't much of this risk be mitigated by buying a portfolio of these CA Municipal bonds with varying maturity dates and from a variety of cities and counties?

It seems that a 5% return is virtually unheard of these days outside of equities with their inherent volatility. Am I the only one who thinks that a 5% yield on this type of investment seems too good to be true, even with the inherent risk?

 

[wolf]

Thanks for the replies so far. I understand that there is risk in almost any investment, but hasn't the default rate on municipal bonds overall been quite low? And doesn't the yield seem too high for an investment that historically has had a low default rate?

Also, couldn't much of this risk be mitigated by buying a portfolio of these CA Municipal bonds with varying maturity dates and from a variety of cities and counties?

It seems that a 5% return is virtually unheard of these days outside of equities with their inherent volatility. Am I the only one who thinks that a 5% yield on this type of investment seems too good to be true, even with the inherent risk?

I think you fail to understand the true "risk". Maybe, someone else can
explain.

Good luck. It sounds as if you have already made up your mind

 

[Texas Proud]

Thanks for the replies so far. I understand that there is risk in almost any investment, but hasn't the default rate on municipal bonds overall been quite low? And doesn't the yield seem too high for an investment that historically has had a low default rate?

Also, couldn't much of this risk be mitigated by buying a portfolio of these CA Municipal bonds with varying maturity dates and from a variety of cities and counties?

It seems that a 5% return is virtually unheard of these days outside of equities with their inherent volatility. Am I the only one who thinks that a 5% yield on this type of investment seems too good to be true, even with the inherent risk?

If you are going after yield.... heck, I found this in about 5 minutes...

SEASIDE CALIFORNIA JOINT PWRS FINANCING TAXABLE-BAYONET AND BLACK HORSE - 812478BK0

Issue details

CUSIP:
812478BK0
Coupon:
7.125%
Maturity Date:
2036-08-01



Since I do not pay the fee, I do not know the rating...


Lots of ones with higher YTM...


FLORIN CALIFORNIA RESOURCE CONSERVATION REFUNDING SUBORDINATED LIEN OFFICE BUILDING SERIES B - 343261GS6
Issue details

CUSIP:
343261GS6
Coupon:
5.300%
Maturity Date:
2017-08-01

Has a current price in the 60s, so yield is 18%



The Definitive Resource for California Municipal Bonds - MunicipalBonds.com

 

[Ready]

I think you fail to understand the true "risk". Maybe, someone else can
explain.

Good luck. It sounds as if you have already made up your mind

Not necessarily, but I do have a significant investment in the Vanguard CA Intermediate Tax Exempt fund. Looking at the prospectus, it appears that most of the bonds in the fund are at about 5% yield. However, due to the way bond funds reset the NAV daily as the market changes, individual bonds can be held for the duration, so that I can count on a steady 5%, and know I'll most likely get the principal back at the maturity date. Holding a variety of these bonds would reduce the risk of any one bond defaulting.

And, I know many people here are not big Suze Orman fans, and I don't listen to everything she says, but she doesn't constantly point out that buy and hold investors are better off with individual bonds than bond funds, so that they can control when they buy and sell them, rather than having the funds controlled by the manager of the bond fund, who has to buy and sell as investors buy and sell shares of the fund.

 

[Gatordoc50]

Not necessarily, but I do have a significant investment in the Vanguard CA Intermediate Tax Exempt fund. Looking at the prospectus, it appears that most of the bonds in the fund are at about 5% yield. However, due to the way bond funds reset the NAV daily as the market changes, individual bonds can be held for the duration, so that I can count on a steady 5%, and know I'll most likely get the principal back at the maturity date. Holding a variety of these bonds would reduce the risk of any one bond defaulting.

And, I know many people here are not big Suze Orman fans, and I don't listen to everything she says, but she doesn't constantly point out that buy and hold investors are better off with individual bonds than bond funds, so that they can control when they buy and sell them, rather than having the funds controlled by the manager of the bond fund, who has to buy and sell as investors buy and sell shares of the fund.

Nothing wrong with individual bonds, IMO. But I prefer AAA of intermediate term or less as my bond portfolio is used to provide stability. If, however, the 30 year treasuries get to 6% plus, I'd put my entire bond portfolio in them.

 

[kaneohe]

Not necessarily, but I do have a significant investment in the Vanguard CA Intermediate Tax Exempt fund. Looking at the prospectus, it appears that most of the bonds in the fund are at about 5% yield. However, due to the way bond funds reset the NAV daily as the market changes, individual bonds can be held for the duration, so that I can count on a steady 5%, and know I'll most likely get the principal back at the maturity date. Holding a variety of these bonds would reduce the risk of any one bond defaulting.

.

How does this work? According to this, https://personal.vanguard.com/us/funds/snapshot?FundId=0100&FundIntExt=INT#tab=4
it looks like the current distribution yield is in the low 3% range (w/ SEC yield at 2.43%). Are you saying that if I bought now and held for the 5.6 yr duration, I would be earning 5%? Not sure I understand how that works.

 

[haha]

Not necessarily, but I do have a significant investment in the Vanguard CA Intermediate Tax Exempt fund. Looking at the prospectus, it appears that most of the bonds in the fund are at about 5% yield. However, due to the way bond funds reset the NAV daily as the market changes, individual bonds can be held for the duration, so that I can count on a steady 5%, and know I'll most likely get the principal back at the maturity date. Holding a variety of these bonds would reduce the risk of any one bond defaulting.

And, I know many people here are not big Suze Orman fans, and I don't listen to everything she says, but she doesn't constantly point out that buy and hold investors are better off with individual bonds than bond funds, so that they can control when they buy and sell them, rather than having the funds controlled by the manager of the bond fund, who has to buy and sell as investors buy and sell shares of the fund.

Is this VCAIX? I found the prospectus. I cannot understand what you mean by your statement that you can get a steady 5%, and "most likely I will get the principal back at the maturity date". What maturity date? It appears that this is a normal mutual fund, with many different bonds maturing at different times, not a target date fund. So it is designed to be perpetual. The SEC yield of 2.4x mentioned by a poster above is the best estimate of what you would earn if you were to buy at the last quoted price.

If in fact one today could buy a selection of tax exempt bonds of this quality and duration at a yield to maturity of 5% something would be broken.

Ha

 

[Ready]

I think I'm using too many compound sentences and confusing the issues here.


What I meant to say is that if I buy individual bonds, I can hold them to maturity and be assured of getting back my principal (assuming no default).

With a bond fund, as people buy and sell shares, the fund managers must buy and sell the individual bonds in the fund, which is what causes the daily NAV to keep adjusting. So there may be more risk, or at least volatility, in holding municipal bonds in a fund rather than individual bonds that you plan to keep until maturity.

The challenge with all this, and this is where I have an issue with Suze Orman's comments, is that the average investor is not prepared to know how to evaluate and purchase individual bonds. It's just as difficult as being savvy enough to understand how to buy individual stocks. And that is why I posted my original question. My own lack of understand with bonds perhaps...but at first glance it would appear these bonds are paying 5%, which seems very high for what has traditionally been a low risk investment. So, I was trying to understand what I'm missing, as it would seem everyone would buy these if it were that simple. And, they are double tax free as well.

 

[haha]

My own lack of understand with bonds perhaps...but at first glance it would appear these bonds are paying 5%, which seems very high for what has traditionally been a low risk investment. So, I was trying to understand what I'm missing, as it would seem everyone would buy these if it were that simple. And, they are double tax free as well.

Thanks for posting back Ready. Is "What am I missing?" a question, or do you feel that you are OK now?

In reading this thread I was never able to see where the 5% came from. You are correct, this I impossible, (unless the relevant interest rates move strongly downward) that is why I said this would indicate a seriously broken market. I assumed that you are in a very high combined tax bracket, and were quoting a tax equivalent rate.

Regarding individual bonds, there is no magic there either. One can only find a 5 year duration municipal bond yielding 5% by feeling that he a good enough analyst to find one selling as junk, but actually A, AA. But that may be a tall order.

Ha

 

[jerome len]

Thanks for the replies so far. I understand that there is risk in almost any investment, but hasn't the default rate on municipal bonds overall been quite low? And doesn't the yield seem too high for an investment that historically has had a low default rate?

Also, couldn't much of this risk be mitigated by buying a portfolio of these CA Municipal bonds with varying maturity dates and from a variety of cities and counties?

It seems that a 5% return is virtually unheard of these days outside of equities with their inherent volatility. Am I the only one who thinks that a 5% yield on this type of investment seems too good to be true, even with the inherent risk?

I would only buy individual bonds through a reputable investment firm such as Vanguard or Fidelity. You CAN get burned fairly bad if you don't know what you are doing. Some bonds are insured, some are/are not tax exempt, some are subject to the alternative minimum tax, and I believe, as an individual investor you have to be VERY careful.

So, if you have an account with a good investment firm ask them if they would buy them for your portfolio. I have been very careful so about 90% of the money I've placed in muni funds are in Vanguard and Fidelity. I have bought some individual muni bonds through Fidelity.

 

[Peter]

How does this work? According to this, https://personal.vanguard.com/us/funds/snapshot?FundId=0100&FundIntExt=INT#tab=4
it looks like the current distribution yield is in the low 3% range (w/ SEC yield at 2.43%). Are you saying that if I bought now and held for the 5.6 yr duration, I would be earning 5%? Not sure I understand how that works.

Coupon yields for bonds in the fund refer to the interest that would be payable if the bond could be purchased at par, that is, the original price. But you will find that all these bonds are priced quite a bit higher than par, since interest rates have gone down since they were issued. The 3% yield represents interest as a fraction of the current price.

 

[kaneohe]

Coupon yields for bonds in the fund refer to the interest that would be payable if the bond could be purchased at par, that is, the original price. But you will find that all these bonds are priced quite a bit higher than par, since interest rates have gone down since they were issued. The 3% yield represents interest as a fraction of the current price.

Peter.......thanks . I think I thought the same but was questioning OP's supposed claim that one could get 5% from that fund.......OP has since confessed to mixing thoughts in a single sentence that could have been misleading.......

This situation reminds me of the old advice on getting contractor's bids........if you end up picking the lowest bidder who is out in left field all by himself and not in the normal distribution w/ others, you're probably going to learn a good lesson....................

 

[Ready]

Coupon yields for bonds in the fund refer to the interest that would be payable if the bond could be purchased at par, that is, the original price. But you will find that all these bonds are priced quite a bit higher than par, since interest rates have gone down since they were issued. The 3% yield represents interest as a fraction of the current price.

Actually, that is exactly what I was trying to figure out, which is why I created the thread in the first place. If you look at the numbers being advertised, which I posted in the original post, am I really getting 5%, or am I buying the bond above par value, so in effect not really getting 5%? Or is there not enough information from the numbers in the ad to know this without calling them to get more info?

 

[haha]

Actually, that is exactly what I was trying to figure out, which is why I created the thread in the first place. If you look at the numbers being advertised, which I posted in the original post, am I really getting 5%, or am I buying the bond above par value, so in effect not really getting 5%? Or is there not enough information from the numbers in the ad to know this without calling them to get more info?

You are not getting 5%, that is impossible. When something is impossible you will not get it.

Best indication of what you will get as YTM is the SEC yield, which combines the current coupon yields with the expected gain, or in this case loss, as the bonds individually approach par at maturity. High coupon bonds will move to a premium if interest rates go down. Funds like these bonds, as they show higher current income.

You don't have to call anybody; this metric is always found in the prospectus or basic description or whatever.

Ha

 

[Gatordoc50]

Actually, that is exactly what I was trying to figure out, which is why I created the thread in the first place. If you look at the numbers being advertised, which I posted in the original post, am I really getting 5%, or am I buying the bond above par value, so in effect not really getting 5%? Or is there not enough information from the numbers in the ad to know this without calling them to get more info?

You would be getting the coupon yield because they are being sold at par. A quick glance at other Ca bonds of similar length show a range of 4.9 to 7.5% YTM. The bonds you mentioned aren't unusual. I believe interest rates on Munis are beginning to pay more because of questions on tax free treatment in the future and increased risk of default. I don't know many investors who find ratings or insurance credible tools to measure risk.

 

[haha]

You would be getting the coupon yield because they are being sold at par. A quick glance at other Ca bonds of similar length show a range of 4.9 to 7.5% YTM. The bonds you mentioned aren't unusual. I believe interest rates on Munis are beginning to pay more because of questions on tax free treatment in the future and increased risk of default. I don't know many investors who find ratings or insurance credible tools to measure risk.

You have found five year investment grade tax exempt bonds with YTMs of 4.9 -7.5%?

Please do us a favor and post some of these here, and then make your everlasting fortune by buying all you can get your hands on.

Ha

 

[Ready]

I'm starting to wonder if when the ad says "priced at $100", it really means $100 par value, and you have to call to get the price.

Looking at some similar bonds available at Fidelity, a CA Muni bond with a 5 year duration and 5% coupon payment is about $115, making the YTM closer to about 1.8%, which is right in line with what the VCADX Muni bond fund is yielding.

 

[Gatordoc50]

You have found five year investment grade tax exempt bonds with YTMs of 4.9 -7.5%?

Please do us a favor and post some of these here, and then make your everlasting fortune by buying all you can get your hands on.

Ha

The bonds mentioned in the OP matured in 2035 and 2042. Where did you get five year?