Municipal Bond Worries

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In 2010, warnings circulated of a looming fiscal crisis among state and local governments. Investor fears intensified and some were motivatedto sell their bonds by a perception of rising credit risk among municipalbonds.

So, is the municipal bond market at risk of massive default? No oneknows - and we are not in the prediction business. But, with that inmind, consider these principles:

  • The municipal bond market is large and diverse. The media often report onmunicipal bond problems as though the market is a single, uniform sector. In reality,the market comprises an estimated 50,000 state and local issuers and about twomillion outstanding bonds.

  • These bonds are rated across a broad spectrum of credit categories and have differentcharacteristics and structures for paying their obligations. Such complexity does notafford simple observations about the market.

  • Historical default rates are low. Muni bonds have a strong track record ofrepayment. One reason is that state and local governments are motivated to avoiddefault since failure to pay affects their ability to raise capital in the future. Anotherreason is that most bonds repay investors either from project revenues or by thetaxing power of the issuer.

  • Municipal bonds are assessed according to actual financials, not models orprojections. Some reports have compared the municipal bond market to the subprimemortgage securities market but the circumstances are different.

  • For one, state and local issuers are subject to financial disclosure rules. Also, municipal bonds are not exotic instruments with complex structures that obscure theunderlying credit rating and market value of the assets. Investors hold an instrumentthat is more transparent than mortgage derivatives.

  • Current market conditions do not imply unusually high risk. The marketincorporates information and expectations into prices, including perceived risk.

In 2010, warnings circulated of a looming fiscal crisis among state and local governments. Investor fears intensified and some were motivatedto sell their bonds by a perception of rising credit risk among municipalbonds.

So, is the municipal bond market at risk of massive default? No oneknows - and we are not in the prediction business. But, with that inmind, consider these principles:

  • The municipal bond market is large and diverse. The media often report onmunicipal bond problems as though the market is a single, uniform sector. In reality,the market comprises an estimated 50,000 state and local issuers and about twomillion outstanding bonds.

  • These bonds are rated across a broad spectrum of credit categories and have differentcharacteristics and structures for paying their obligations. Such complexity does notafford simple observations about the market.

  • Historical default rates are low. Muni bonds have a strong track record ofrepayment. One reason is that state and local governments are motivated to avoiddefault since failure to pay affects their ability to raise capital in the future. Anotherreason is that most bonds repay investors either from project revenues or by thetaxing power of the issuer.

  • Municipal bonds are assessed according to actual financials, not models orprojections. Some reports have compared the municipal bond market to the subprimemortgage securities market but the circumstances are different.

  • For one, state and local issuers are subject to financial disclosure rules. Also, municipal bonds are not exotic instruments with complex structures that obscure theunderlying credit rating and market value of the assets. Investors hold an instrumentthat is more transparent than mortgage derivatives.

  • Current market conditions do not imply unusually high risk. The marketincorporates information and expectations into prices, including perceived risk.

How to Take Prudent Risks with Municipal Bonds

So how is PartnersInWealth evaluating municipal bond risk? Here are a few guidingprinciples:

  • Hold shorter-term bonds. Bond prices move in the opposite direction of interest ratechanges—and the longer a bond’s maturity, the greater its price change. Favoringshorter- term bonds can help reduce price changes.

  • Stay broadly diversified. Hold many municipal bond issues and avoid concentrationin a particular state, sector, or type. This approach can help reduce the impact of afew non-performing bonds. If default rates were to rise, investors with a welldiversified municipal portfolio would be less exposed.

  • Focus on quality and use market pricing to confirm credit ratings. The mostcreditworthy bonds are those rated AAA or AA. Most of the current problems involvelower-rated bonds.

Like most investments, municipal bonds are part of a complex market with any numberof forces acting on them to affect the price. While media reports can point out part of thepicture, there is often more to the story that the investor must evaluate. PartnersInWealth takes the important principles mentioned above to select suitablemunicipal bond investment vehicles for our client’s investment portfolio. clients true financial security and peace of mind.

How to Take Prudent Risks with Municipal Bonds

So how is PartnersInWealth evaluating municipal bond risk? Here are a few guidingprinciples:

  • Hold shorter-term bonds. Bond prices move in the opposite direction of interest ratechanges—and the longer a bond’s maturity, the greater its price change. Favoringshorter- term bonds can help reduce price changes.

  • Stay broadly diversified. Hold many municipal bond issues and avoid concentrationin a particular state, sector, or type. This approach can help reduce the impact of afew non-performing bonds. If default rates were to rise, investors with a welldiversified municipal portfolio would be less exposed.

  • Focus on quality and use market pricing to confirm credit ratings. The mostcreditworthy bonds are those rated AAA or AA. Most of the current problems involvelower-rated bonds.

Like most investments, municipal bonds are part of a complex market with any numberof forces acting on them to affect the price. While media reports can point out part of thepicture, there is often more to the story that the investor must evaluate. PartnersInWealth takes the important principles mentioned above to select suitablemunicipal bond investment vehicles for our client’s investment portfolio. clients true financial security and peace of mind.