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Your municipal bond may only be secured by the promise to pay and when it comes to promises, not all are created equal.

Municipal Bonds Are Different

February 3rd, 2017 by Kurt L. Smith
  • While technically all municipal bonds are government bonds, municipal bonds represent a subset of government bonds. Unlike the behemoth debt associated with almost all countries on the planet, including ours, municipal bonds are, well, usually smaller and sometimes just small.

    Size matters, except when it comes to debt, bigger usually is not better. This is a qualitative difference where municipal bonds have the ability to shine. Unlike the debt upon debt upon debt of most government debt today, municipalities have the ability to truly be unique in their amount of leverage.

    All five year bonds are five year bonds. And almost every five year government bond will be repaid because the government has promised to repay it. These government bonds carry the “full faith and credit” of their issuer to be repaid and are known as general obligation bonds.

    When it comes to general obligations, bigger can indeed be better. Larger governments usually have more resources and usually are viewed as being less risky, or even safe or without (credit) risk as United States treasury bonds were viewed.

    It has not been until recently that analysts and credit rating firms began to question the safety of government bonds previously believed to be risk-free. Why? Because the amount of debt outstanding, seemingly ever growing, might make a difference in the quality of the issuer and the safety of the bonds.

    When an asset class is not only trending higher but has entered a manic place, as Bonds experienced last year, qualitative differences usually take a back seat. Who cares…look at those market prices! Manias are like this; the stock market is currently like this.

    We have not been investing assuming the mania will continue. Manias do not continue; they usually end badly…quite badly. We assume qualitative differences may not matter at any given moment, but they just might. The best part however is, when others choose to ignore qualitative differences, we have the opportunity to choose a better bond, usually without paying extra.

    Now that the bond mania has ended, as well as the thirty-year-plus bond bull market, qualitative differences will probably begin to be talked about again. When prices decline, narratives are created to explain why this has happened. Qualitative differences, such as the issuers rating (or lack thereof) or leverage or whatever, can and will be used to explain the situation.

    Longer-term bonds are lower in price (and higher in yield) primarily because they are longer-term bonds. Avoiding longer-term bonds is the preliminary way to avoid lower prices. Qualitative differences matter, but almost all longer-term bonds are lower in price today compared to last summer, regardless of their qualitative differences.

    Unlike the seemingly generic non-variety of government bonds, municipal bonds offer a variety of differences that I believe make municipal bonds an asset class like no other. Not all municipal bonds are general obligations of their issuer. In fact, a sizable percentage of the $3.6 trillion municipal bond market are issued, not as general obligations, but are designed to be repaid by some specific source.

    Looking at a bond on your statement may give you little clue regarding the qualitative differences between it and another bond. Whereas five year government bonds are just that (a five year bond a government promises to repay), a five year municipal bond may be something entirely different. Your municipal bond may have collateral that helps ensure repayment. Your municipal bond may only be secured by the promise to pay and when it comes to promises, not all are created equal.  The way a bond appears on your statement may or may not help you determine how your bond is repaid; the terms and conditions spelled out in the bond’s Official Statement contains the terms and conditions.

    It is the variety of the municipal bond market that makes it unique. It was our strategy to avoid longer-term bonds that has protected portfolio values as the bond market trend has changed. It is our Select Approach that provides for returns as well as providing for opportunities at higher yields.

    Every day the variety in the municipal bond market allows us to select bonds we believe to be worthwhile opportunities in the months and years to come. Other, more generic markets, offer few alternatives (longer/shorter, fixed/variable) whereas we have a myriad of choices in the municipal bond market.

    With the bond markets trending lower in price and the stock markets manic period finishing up, financial assets may no longer offer the store of wealth many have come to expect from them. Trends change but it is the variety inherent in municipal bonds that can provide opportunities not available in other asset classes.

    Aldine Independent School District, Texas Refunding GO

    Moody Aaa (Aa2 Under) S&P AAA (AA- Under)

    Permanent School Fund Guaranteed

    Due 2/15 Dated 2/15/17 Maturity: 2/15/2033

    Sale Amount: $101,050,000

    YEAR MATURITY COUPON YTM*
    1 2018 3.00% 0.93%
    2 2019 2.00% 1.23%
    2 2019 5.00% 1.23%
    3 2020 5.00% 1.44%
    4 2021 5.00% 1.65%
    5 2022 5.00% 1.84%
    6 2023 5.00% 2.02%
    7 2024 2.50% 2.22%
    8 2025 5.00% 2.39%
    9 2026 5.00% 2.53%
    10 2027** 5.00% 2.63%
    11 2028** 5.00% 2.72%
    12 2029** 4.00% 2.96%
    13 2030** 4.00% 3.09%
    14 2031** 4.00% 3.22%
    15 2032** 4.00% 3.33%
    16 2033** 4.00% 3.39%

      *Yield to Worst (Call or Maturity) **Par Call: 2/15/2026

    Source: Bloomberg

    This is an example of a new issue priced the week of 1/30/17

    Prices, yields and availability subject to change

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