muni bonds are poised for serious problems

[JBmadera]

she did a follow up interview on CNBC this morning. Unsettling, to say the least.

 

[brewer12345]

she did a follow up interview on CNBC this morning. Unsettling, to say the least.

Or maybe she is just another bimbo desperate for attention so that her 15 minutes of fame don't end on schedule.

 

[veremchuka]

she did another interview at 3:30 with maria bartoromo. cities and states can't print money like the feds can. if they go bankrupt wouldn't their bonds be worthless? bonds are in your portfolio for stability not to provide juicy returns, taking risk is done with equities. munis seem very dangerous.

 

[brewer12345]

bonds are in your portfolio for stability not to provide juicy returns, taking risk is done with equities.

Munis aside, this is a big misconception. Under the right circumstances it is quite possible to generate equity-type returns with bonds, usually with less volatility than equities. You should always be on the lookout for big potential returns, regardless of the instrument. If you could lock in a double digit return via a 5 year bond issued by a stable, investment grade issuer, wouldn't you find that exceedingly attractive? So what if it isn't an equity.

 

[79protons]

Munis aside, this is a big misconception. Under the right circumstances it is quite possible to generate equity-type returns with bonds, usually with less volatility than equities. You should always be on the lookout for big potential returns, regardless of the instrument. If you could lock in a double digit return via a 5 year bond issued by a stable, investment grade issuer, wouldn't you find that exceedingly attractive? So what if it isn't an equity.

Which has more risk? A bond from a city in Illinois or stock in a company like Coca Cola, Walmart, or Mcdonalds?

 

[Rambler]

I'm not selling. Of course I will keep an eye on them, but I'm not too worried. I'm more likely to snatch up more as the prices go down and the yields go up.

R

 

[harley]

Many masochists in that part of the country. No other reason to be there.

Ha

Other than that it's a long way from California.

 

[freebird5825]

Many masochists in that part of the country. No other reason to be there.
Ha

Other than that it's a long way from California.

You guys crack me up!

 

[brewer12345]

Which has more risk? A bond from a city in Illinois or stock in a company like Coca Cola, Walmart, or Mcdonalds?

Almost certainly the equity has higher risk, although at the moment relative prices of the bonds vs. the equities likely compensate you for this. But bond markets, especially smaller ones, throw up highly profitable anomalies from time to time and we should be prepared to grab them. Its easier to spot the opportunities in bond markets because all you have to do is figure out if the issuer can stay enough in one piece to pay you off. Equities are much tougher.

 

[scrabbler1]

I have been in two muni bond funds since the early-mid 1990s. One is a national (intermediate-term) bond fund and the other is a single-state (long-term, New York) bond fund.

Both funds had their NAVs took a big hit in 2008 and into 2009 before rebounding well into 2010 even though the monthly dividend yields have dropped a little. The NAVs are back down to where they were about one year ago.

A national muni bond fund is more diversified than a single-state fund, of course, so one or two states having problems is not going to affect the overall fund a whole lot. But I would be a little nervous about investing in a single-state fund if that state is having more problems than most others. In the 60 Minutes segment, Illinois was singled out as a state with some extraordinary issues. (I don't live in Illinois so it is not a fund I would not buy into it; my national fund has only 2.1% of Illinois bonds.)

On the local side, my county (Nassau) had some fiscal problems about 10 years ago and the state stepped in with some aid along with an oversight board. The bond rating went down but remained at the low end of investment grade. With a new administration, the bond rating recovered over the years since then but with another new administration in place last year some of the old fiscal practices from the 1990s which got us into the mess have begun to resurface, drawing extra attention from the oversight board (which has the power to become a control board). [I don't know of an oversight board type of relationship between the feds and the states should a state get into trouble the way my county did.]

A locality in some trouble fiscally can present a good buying opportunity. My parents bought a single 15-year coupon bond ($10k) for Long Island's Suffolk County back in the mid-1980s when Suffolk had some fiscal problems and saw its bond rating downgraded. It had an interest rate of about 8%, not bad for a muni. Suffolk got its act together and the bond paid about $400 every 6 months for 15 years without any problems.

 

[MichaelB]

Which has more risk? A bond from a city in Illinois or stock in a company like Coca Cola, Walmart, or Mcdonalds?

+1 on what Brewer said.

This is one of the problems with the muni market. It is broader than the sum of corporate investment grade + junk + emerging market + developed country sovereign. Having Florida development districts in the same category as State of Florida and Yankee stadium parking garage doesn’t make sense. That means generalities about “the muni market” also don’t make sense.

One final comment. There is a recent Dan Fuss radio interview with Consuelo Mack (promoting a paid subscription service, this interview is free). Fuss was investing in bonds before Meredith Whitney was born and is without any doubt a real expert on the subject. I would choose his advice over hers without hesitation. Anyone concerned about their bond investments should listen. Link here Home - Consuelo Mack WealthTrack Extra

 

[79protons]

Almost certainly the equity has higher risk, although at the moment relative prices of the bonds vs. the equities likely compensate you for this. But bond markets, especially smaller ones, throw up highly profitable anomalies from time to time and we should be prepared to grab them. Its easier to spot the opportunities in bond markets because all you have to do is figure out if the issuer can stay enough in one piece to pay you off. Equities are much tougher.

It is not only default risk in a muni bond you need to worry about, but rising interest rates. A 1% increase in interest rates will have a much larger detrimental effect on the principal.

I am also not sure if a lot of cities could remain current on their bond payments if Coca Cola, Walmart and Mcdonalds all suddenly went bankrupt.

So really, I am not so sure what has more risk.

 

[MichaelB]

It is not only default risk in a muni bond you need to worry about, but rising interest rates. A 1% increase in interest rates will have a much larger detrimental effect on the principal.

I am also not sure if a lot of cities could remain current on their bond payments if Coca Cola, Walmart and Mcdonalds all suddenly went bankrupt.

So really, I am not so sure what has more risk.

The question was risk, not return. BTW, it was not an equitable comparison. Better would be Coca Cola stock vs NY State bond. The risk from the bond is lower - which is why the potential return is higher for the stock.

 

[brewer12345]

It is not only default risk in a muni bond you need to worry about, but rising interest rates. A 1% increase in interest rates will have a much larger detrimental effect on the principal.

I am also not sure if a lot of cities could remain current on their bond payments if Coca Cola, Walmart and Mcdonalds all suddenly went bankrupt.

So really, I am not so sure what has more risk.

That is truly a stunning series of non sequiturs. You should print it out and frame it.

If I can buy a good quality muni at double digit yields and stay within a 10 year maturity limit, I will not be worrying too much about interest rate risk. If I were worried about interest rate risk, I would hedge via treasury ETFs or more likely puts on same.

 

[79protons]

That is truly a stunning series of non sequiturs. You should print it out and frame it.

If I can buy a good quality muni at double digit yields and stay within a 10 year maturity limit, I will not be worrying too much about interest rate risk. If I were worried about interest rate risk, I would hedge via treasury ETFs or more likely puts on same.

I don't understand why you are saying my statements are illogical.

First off, you can't buy a good quality muni at double digit yields, so that statement by you is illogical.

I think pointing out that bonds suffer from interest rate risk when current rates are absurdly low is a valid arguement. Stocks offer some protection from rising interest rates, bonds offer nothing there.

My last statement was sort of tongue in cheek, but it pointed out that in the event of such a horrible economy that caused staples like Walmart, Coke, and McDonalds to go belly up would be an economy where the repayment of municipal bonds would be a last priority. How much rioting would there be if you raised taxes during a time of 25% unemployment?

I am not saying that muni bonds will be defaulted upon, but I am also saying there is very little market risk in owning a mix of large cap value companies paying a nice little divy. I personally believe the equity has slightly lower risk than the bond, in today's market.

 

[brewer12345]

Good luck with those risk assessments.

 

[79protons]

Good luck with those risk assessments.

thanks. I harvested a 2% capital loss on my Vanguard VWITX fund today (although it was positive if you count the interest) and invested in a much more stable mix of large caps. Having losses in something that pays about like a bank CD isn't my idea of good risk vs reward, but to each his own I guess. If we get to the point where VWITX is paying 6% or so, i will re-evaluate the situation.

 

[veremchuka]

brewer12335,

do you buy junk bonds or junk bond funds? they have high yields too but are considered risky and by many inappropriate as a fixed income holding. i am not an expert on any bonds but munis just seemed to be poised for defaults should cities and states start going broke. pension and benefits promised to current and future retirees sound like they can not be met in this economic environment or over the next 40 years.

an 8% yield on a muni, sounds great, but is there is a reason why that coupon is so high? look at bonds from greece or ireland or portgual, they have high coupons too and for good reason. i am not saying you are wrong rather i am citing what i see as warning signs and remembering the ole saying if it looks too good to be true....

 

[dessert]

Is anyone on this board going to sell his/her municipal bonds ? I am thinking of selling mine.

I didn't own municipal bonds but I bought into 4 different municipal bond funds in January 2010. They were a mix of short, intermediate and long.
They did well all year long until QE2 announcement which included the end of Build America Bonds for 2011. Those funds fell like a rock and I finally sold them all right before I started losing principal. In four weeks time the funds lost the entire years worth of dividends paid as well as all of the Capital Gains for the year. I had chosen those funds to replace "money market" cash and I had a low risk tolerance for that money so I sold.
I know we're not supposed to try and time the market but I just didn't understand what was going on and I went against "buy and hold" and sold anyway.
Thanks to Brewer for helping me understand what was going on. I personally think it was the right decision for me anyway.

 

[79protons]

I didn't own municipal bonds but I bought into 4 different municipal bond funds in January 2010. They were a mix of short, intermediate and long.
They did well all year long until QE2 announcement which included the end of Build America Bonds for 2011. Those funds fell like a rock and I finally sold them all right before I started losing principal. In four weeks time the funds lost the entire years worth of dividends paid as well as all of the Capital Gains for the year. I had chosen those funds to replace "money market" cash and I had a low risk tolerance for that money so I sold.
I know we're not supposed to try and time the market but I just didn't understand what was going on and I went against "buy and hold" and sold anyway.
Thanks to Brewer for helping me understand what was going on. I personally think it was the right decision for me anyway.

This is my point. Everyone says muni bonds are so safe, and yet you give an example of practically worse performance than sticking the money in your matress. I made about 1% on my muni bonds in a year, so did a bit better than you. Was it worth risking principal for a 1% return? Hell no.

 

[dessert]

This is my point. Everyone says muni bonds are so safe, and yet you give an example of practically worse performance than sticking the money in your matress. I made about 1% on my muni bonds in a year, so did a bit better than you. Was it worth risking principal for a 1% return? Hell no.

If I hadn't sold, it would have been much worse than having money in the mattress. I did make a few $$ but If I had sold when I first became suspicious of what was going on, I would have been "a genius". (I know...hindsight).

 

[dex]

BigCharts - QuickCharts

BigCharts - QuickCharts

It isn't just the munis the Vanguard Long Term Treasuries took a similar hit.
My only guess is that the market is expecting interest rates to go up. The $ has gotten stronger.


http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=DXY&sid=3044712&time=

 

[clifp]

Is anyone on this board going to sell his/her municipal bonds ? I am thinking of selling mine.

My muni position is down from 300K, in 1999 when I was working and had just retired, to single position from Puerto Rico 15K. (Brewer says PR finances are horrible BTW) I have sold some bond, had a few redeemed but the bulk of them have been called away.

To me the call risk is one under appreciated risk of own individual munis and too a lesser extend muni funds. At least they were to me when my initial plan was to have $1 million worth of muni's @5% giving 50K tax free pension.

Almost all muni's have a call provision, which allows the bond to call at par or with a small premium typically after 5 year.

Unlike corporations which may only issue debt for special project, municipalities are constantly rolling over the debt. Hence part of the problem. So they are constantly engage in interest rate arbitrage.

Say that we have a normal yield curve and 10 year muni's are 3%, 20 3.5% and 30 year 4%. You have a healthy pension, and lots of interest and rent income and so muni's make sense from a tax prospective. You buy some 30 years bonds for your retirement. As we know if interest rates rise the value of the bond goes down, but the nominal income rise. What if rates go down, well the bonds don't go up much because of the call provisions, and municipal do call them. So suddenly you find yourself with cash you don't need and have to invest that you hadn't plan on.a

The real gotcha is even when interest rates remain flat your bonds still get called. Let say that your 30 year bond was paying 4% 10 years go by and 20 year bonds are still 3.5%. They'll issue a 20 year bond a save the 1/2 percent per year. That is what a San Diego utility did recently with one of my 30 years bonds with 16 years left, even that it was only A rated they called my bond than floated a new issue with a 15 year maturity. You see the same phenomena with muni bond funds in the form of lower distributions even the price is going up.

 

[clifp]

There is still IMO a real danger with default risk for muni's. It isn't huge but it is an order of magnitude larger than it has been in our lifetime.


Here is article from the WSJ that points out a fight we may see on the board....

For cities and towns facing unsustainable pension costs, the end game may look something like Prichard, Ala.
The financially troubled suburb of Mobile turned to bankruptcy court in October 2009 when it "simply ran of money to pay its pension obligations," says the city's lawyer R. Scott Williams.
Prichard proposed capping benefits to current retirees at about $200 a month, down from monthly payments of as much as $3,000. "That's not a hair cut, that's a scalping," said Larry Voit, who represented a group of 40 retired city workers in Prichard, population 27,500.
Though bankruptcy law remains murky on how far a city or town can go in scrapping deals for current retirees, cases like Prichard and other workout efforts stand to reshape the debate over how local governments deal with mounting public-pension problems.
The stakes are high for taxpayers, public workers and bondholders, as concerns escalate about whether governments can pay their debts.

...

But Chapter 9 remains a largely untested corner of the bankruptcy code, and bondholders aren't necessarily insulated from loss, lawyers say. Vallejo, Calif., which sought bankruptcy protection in 2008, is still negotiating with holders of $52 million in debt over terms of a possible haircut, according to the city's lawyer.

So there you have issue ;do retirees with pensions get hosed, or do bond holders get screwed.? Perhaps the state or Uncle Sam rides to the rescue?

It does appear that Chinese curse of "may you live in interesting times" has afflicted us.

 

[brewer12345]

brewer12335,

do you buy junk bonds or junk bond funds? they have high yields too but are considered risky and by many inappropriate as a fixed income holding. i am not an expert on any bonds but munis just seemed to be poised for defaults should cities and states start going broke. pension and benefits promised to current and future retirees sound like they can not be met in this economic environment or over the next 40 years.

an 8% yield on a muni, sounds great, but is there is a reason why that coupon is so high? look at bonds from greece or ireland or portgual, they have high coupons too and for good reason. i am not saying you are wrong rather i am citing what i see as warning signs and remembering the ole saying if it looks too good to be true....

At the moment I own one "true" junk bond and a "crossover credit/5 Bs" bond. The former matures in 4 years and the issuer will likely call it within 2. I bought at 60 cents on the dollar and I am just clipping coupons until the call or maturity as I am comfy with the issuer. The latter is a company which is split rated (one investment grade rating, one junk), the sort of think the VG junk fund owns. It matures in 4.5 years and I bought it at 67 cents on the dollar. I am comfy with the issuer and it trades "by appointment only" (illiquid), so I will hold it until maturity or a fat bid shows up. Other than that, I liquidated my junk (especially funds) because what I owned was deeply junky and had been bought down in the pit of the credit market crash. The VG fund is much higher quality and a smaller allocation would be OK to hold as part of a diversified portfolio.

The junk market is a funny thing. In good times, I really am not interested in owning the whole market because there are too many underpriced risks in it, although I will grab a distressed name from time to time if it is a compelling value. However, the junk market regularly blows up (every 3 to 5 years) and when it does junk can get very attractive. Most of the time, you still would not want to own the whole junk market because there are too many messes. But if you can do credit work and distinguish between the survivors and the likely bankruptcies, you can make a killing since the good names sell off with the bad. So in 2009 I bought bonds trading from 30 to 75 cents on the dollar (and some were investment grade) because the market was grossly mispricing these names.

If the muni market has a blowup, I intend to be be standing by to pluck the pearls out at porkchop prices, just as I do with the junk market when it blows up. The muni market is dominated by retail investors (dumb money) to a far greater extent than the taxable bond market. As such, I would expect a blow up to show really big mispricings of individual issuer risk.

Will we see a muni bond market implosion? I dunno, but if it happens I will be ready.