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Default on Municipal Bonds
Old 01-27-2023, 09:59 AM   #1
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Default on Municipal Bonds

I have been dealing with my in-laws' finances lately. My FIL has had undiagnosed Alzheimer's for years, and he was prone to stock picking and loading up on large amounts of long-term muni bonds in Missouri. He was obsessed with income and 5% yields. One of them has recently outright failed, and another, coming due this Nov., has a market value of 50% of face, so I think it might fail as well. I found a big study on Muni default on Fidelity that I am wading through -

https://www.fidelity.com/bin-public/...cipal-bond.pdf -

But I'm wondering what experience the investors here have had with individual muni bonds and defaults. My in-laws are in their 80s, and they are holding of individual bonds with maturities decades out that are currently underwater.

We could try to hold them until maturity, sell them at a loss, or wait to see if interest rates come way back down at which point these bonds might be worth more. Any other ideas?

I guess those articles I sent him on indexing didn't exactly stick.
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Old 01-27-2023, 10:03 AM   #2
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I have owned munis for years and never had a default. The defaults I am aware of were related to senior care facilities.
Here is a chart showing defaults. If you can post the cusip numbers, I can comment further.
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Old 01-27-2023, 10:44 AM   #3
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I own munis through a Separately Managed Account with my broker. I own the individual bonds but they make all the decisions. The account is managed by Lord Abbett and they pretty much buy and hold to maturity unless they see something going south.

I've had this account for about 5 years- very happy, no defaults.
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Old 01-27-2023, 11:04 AM   #4
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Thanks COcheesehead. The one that should have paid out and didn't is 05873WAP7 .

The one I'm currently worried about is 476251AB9

And less so, because it is so far from maturity: 85236BAC6
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Old 01-27-2023, 11:20 AM   #5
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What stands out at first glance on all of these is that they are unrated. Maybe some or all were rated previously, but not now.

First rule of thumb - you want investment grade. If it is unrated, unless you have hard evidence of strong financials, I would steer clear.
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Old 01-27-2023, 05:57 PM   #6
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Quote:
Originally Posted by tricky88 View Post
I have been dealing with my in-laws' finances lately. My FIL has had undiagnosed Alzheimer's for years, and he was prone to stock picking and loading up on large amounts of long-term muni bonds in Missouri. He was obsessed with income and 5% yields. One of them has recently outright failed, and another, coming due this Nov., has a market value of 50% of face, so I think it might fail as well. I found a big study on Muni default on Fidelity that I am wading through -

https://www.fidelity.com/bin-public/...cipal-bond.pdf -

But I'm wondering what experience the investors here have had with individual muni bonds and defaults. My in-laws are in their 80s, and they are holding of individual bonds with maturities decades out that are currently underwater.

We could try to hold them until maturity, sell them at a loss, or wait to see if interest rates come way back down at which point these bonds might be worth more. Any other ideas?

I guess those articles I sent him on indexing didn't exactly stick.
we have roughly 1/7th of our net worth in a muni bond ladder spread between 1-5 year maturities. so far, so good.
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Old 01-27-2023, 06:00 PM   #7
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Here's a badly-written news article on (I believe) the borrower of the first bond, a TIF district in Ballwin, Mo. The story says they can't repay the debt, but gosh, they're good-natured about it. https://www.westnewsmagazine.com/new...4433bea07.html
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Old 01-27-2023, 06:11 PM   #8
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Thanks COcheesehead. The one that should have paid out and didn't is 05873WAP7 .

The one I'm currently worried about is 476251AB9

And less so, because it is so far from maturity: 85236BAC6
Here is how you can find out all you need to know. Search the cusip number, then click on ME - material events. It will have all the latest news.

The first one 05873WAP7 is in default as of last October. You can read more at the ME.
The second one was called or partially called last September.
The third one is about to default. They had to draw on reserves to make the last interest payment.

I have no idea if any of these were rated initially or what the ratings were, but likely they were not rated as investment grade. You would almost have to go way out of your way to find any worse muni bonds. Munis are safe. These are exceptions beyond compare.
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Old 01-27-2023, 06:20 PM   #9
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Here's a badly-written news article on (I believe) the borrower of the first bond, a TIF district in Ballwin, Mo. The story says they can't repay the debt, but gosh, they're good-natured about it. https://www.westnewsmagazine.com/new...4433bea07.html
There are two types of muni bonds, revenue and general obligation.

Revenue bonds depend solely on the revenue generated by the entity, in this case the town plaza. They are riskier because the source of the revenue is narrower. Not all revenue bonds are bad. Airports and toll roads are example of ones that are usually good.
The general obligation or GO bonds recieve income from taxation of the people and are considered safer because, well you know the old saying about death and taxes.
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Old 01-27-2023, 06:49 PM   #10
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There are two types of muni bonds, revenue and general obligation.

Revenue bonds depend solely on the revenue generated by the entity, in this case the town plaza. They are riskier because the source of the revenue is narrower. Not all revenue bonds are bad. Airports and toll roads are example of ones that are usually good.
The general obligation or GO bonds recieve income from taxation of the people and are considered safer because, well you know the old saying about death and taxes.
I try to stay away from tax-incremental financing bonds. They are usually reliant on the success of a commercial development, which makes them relatively risky on the muni spectrum.
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Old 01-27-2023, 06:53 PM   #11
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Reading between the lines of the poorly written article linked above, the revenue to repay the debt did not meet expectations. Property taxes were impacted by values dropping in 2008 ( housing crash). Many of the original tenets left and were replaced by lower revenue businesses. Itís all good though because the town got new roads and infrastructure. A cautionary tale I am following keenly to learn how to protect myself.
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Old 01-27-2023, 07:23 PM   #12
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The second CUSIP tricky88 mentioned is for another TIF bond, but it looks like it has been making partial calls biannually for the last several years. The calls haven't been particularly large but Tricky, some principal should have been returned twice every year since 2015.

The bond issue was for an interesting project, redevelopment of the landmark Northland Shopping Mall property in suburban St. Louis. According to some websites it was one of the first suburban shopping malls in the metro area. It came down in the early 2000s and was replaced with the Buzz Westfall Plaza strip mall anchored by a Schnuks supermarket and a Target. The Target is gone now, replaced by a Goodwill, if my Google Satellite image is correct. Judging from the parking lot, the Schnuks looks busy, the Goodwill notsomuch.
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Old 01-27-2023, 07:29 PM   #13
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Corporate bonds for retail establishments are risky. Muni bonds for retail establishments sound like a disaster.
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Old 01-28-2023, 12:36 AM   #14
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I canít recall if they were munis, but there were some special tax authority bonds in TX recently for construction of a mixed use development that was primarily distribution facilities. It seemed speculative to me. Not backed by any local govít. Other revenue issues Iím wary of include private education and industrial development agencies. I do hold some transportation authority and state hospital bonds. Iím really only interested on GOs at this point.
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Old 01-28-2023, 03:51 AM   #15
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Other revenue issues I’m wary of include private education and industrial development agencies. I do hold some transportation authority and state hospital bonds. I’m really only interested on GOs at this point.
The nice thing with private education and hospitals in general is that it is extremely easy to take a couple minutes and look at their financials, especially their level of endowments and investments held, and their cash flow statement to gain a quick understanding if they are self-sustaining or they are money pits. Charter schools are the worst of what I've seen in these. Big name, and even smaller private universities generally have strong financials and large endowments, similar with big name hospital systems. But again, it's important for the investor to take the time to review the financial statements and Moody's/S&P reports (if available) to have greater understanding of what they are investing in.

Generalizing is usually fine for having a quick way to avoid a potential problem, but looking just a little deeper is what will uncover the gems which are being discarded unjustifiably and presenting opportunity.

Maybe 15 years ago, when DW's employer/hospital was building a new facility, they sent around their offering statement to staff to give them opportunity to purchase the bonds from the underwriter directly before they were offered to the public. The rating agency gave them a BB rating. When DW gave me the offering statement, I laughed and tossed it in the trash. I forget what the coupon or maturity was, but since they were clearly not investment grade, there was no need to consider any further.
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Old 01-28-2023, 04:58 AM   #16
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Other than the moodys/s&p ratings, are there filters in the brokerages tools to screen out the non-GO Munis? There are far too many offerings to manually research them all.
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Old 01-28-2023, 05:47 AM   #17
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Other than the moodys/s&p ratings, are there filters in the brokerages tools to screen out the non-GO Munis? There are far too many offerings to manually research them all.
Fidelity does provide a checkbox to include/exclude GO vs. revenue munis.

Most of what you can utilize to screen will leave you with a set of bonds which fall under the "generalities" for weeding things out, which should lead to further investigation as opposed to simply jumping to the Buy button.

Looking at the high end of current yield (as opposed to the coupon) will obviously give you a reading on negative investor sentiment and what you might want to stay away from, and the opposite for low end of current yield. However, because the muni market is so illiquid, this often can be misleading, especially when it comes to retail investors and small lots. Efficient Market Hypothesis does not hold here.

For non-GO munis, a few things you can screen for that should give you positive or negative vibes include:
1. Escrowed and pre-refunded - about as safe as you can get. The money has been set aside for all future interest and principal at maturity payments. These funds have been transferred to an escrow agent (bank) that controls and manages the funds generally having them invested in government securities through redemption/maturity.

2. Bond Insurance - similar to FDIC for CDs, insured bonds come with an insurance policy which has been purchased by the issuer from one of the handful of muni bond insurers. This has a couple of angles to look at it from. First, you have insurance that if the bond defaults, the insurer will cover any shortfall. However, should there be a wave of muni defaults, it's possible that muni bond insurer(s) could fail. An issuer would need to purchase bond insurance if it were viewed as riskier, while a stronger issuer has no need to have insurance. The stronger issuer might be able to issue bonds at a lower coupon without the bond insurance, while a weaker one would not. So, again, though this can provide some guidance, deeper investigation should be taken.

3. Shorter maturities vs. longer ones. There is less risk in shorter term maturities for a number of reasons. First, current financials will immediately tell you if the issuer is financially able to make payments for the next, say, 1 to 5 years. An issuer which potentially has difficulties in that time frame will have already seen their bonds take a hit, providing red flags. Additionally, in general, most muni bond issues, especially those which have their maturity 20+ years out have larger/balloon payments in the final year or two of the bond issue. The payments/maturities in the earlier years are generally lower and easily handled. When those larger/balloon payment are dealt with, it's most often done through refinancing.

4. Material events - these should be considered for red flags. Missed filings, significant changes in operations/income/expenses (e.g. Covid-related things), rating changes, and so on. Generally, the broker's screening will not go into the material events. Fidelity provides a tab on the bond details, but you have to manually go through them. Using EMMA (emma.msrb.org) provides better query facilities for identifying munis and screening material events. The difficulty here is that querying from the EMMA side gives you bonds that exist, as opposed to querying from the broker side which is going to give bonds that are currently in inventory and being offered for sale. So, generally the process is to identify the bonds available for purchase through the broker's query facilities, then go to EMMA and spend some time looking at more detail.
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Old 01-28-2023, 07:13 AM   #18
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This conversation reminds me of the Oppenheimer Champion Muni Bond fund in the 2000s. It was making 8-10% a year (Tax free! Safe!) for years. People who didn't dig deep into it loved it. Until it failed. And dropped 80%. And then never recovered. And then closed. The fund was using heavy leverage to make those magical "safe" returns. If it seems too good to be true...
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Old 01-28-2023, 07:37 AM   #19
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I concluded, hopefully correctly, that 18 months or shorter that are some flavor of "A" are plenty safe, regardless of GO vs revenue. With the help of this thread, I got a list of defaults, and figured I'd stay away from US territories, but otherwise grab one of the best rates. And this is without digging into the underlying financials.
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Old 01-28-2023, 09:12 AM   #20
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Other than the moodys/s&p ratings, are there filters in the brokerages tools to screen out the non-GO Munis? There are far too many offerings to manually research them all.
NJHowie is the muni king and use the screen features he mentions. GO vs revenue is an easy checkbox.

Revenue bonds will usually have better returns, just do your homework. I own a bunch, you donít have to avoid them, just understand how they receive revenues.
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