We want to believe it simply isn’t so. Municipal bonds or munis, those hometown or home state, often tax exempt debt instruments which are favored among the retired, the soon-to-be retired or those looking for a conservative but well-paid return may be facing a little headwind. But truth be told, you should have noticed.
When you buy a municipal bond, you are essentially buying a project believed to be worthwhile for the city, county or state issuing the debt. They are rated in much the same way as a corporate bond is with a single exception worth noting. If a municipality issues a bond and has difficulty paying the coupon, they often simply raise the local tax rate to cover the shortfall. But like all sorts of funding, the increased tax revenue that would pay for the bond payment shortfall is also in short supply.
This means trouble for what was once the set-it-and-forget investment. Although not all bonds issues by these locales are in trouble. Many of the projects that are vital to city and county services, such as water and sewer projects are considered among the safest. As one city planner recently suggested, folks will pay for their water and sewer bill increases even though they might complain.
But some bonds issued are dependent on public support for their success and their repayment of the debt. If that new stadium fails to attract the projected number of ticket buyers, trouble could be looming for the bondholder. There is only so much fans are willing to pay for seats and hotdogs. If the cost of a light rail system cannot be offset by attracting businesses along its routes, the city is not likely to raise taxes to help support a poorly planned project.
What is likely to happen is a missed payment. Just like your own personal accountability when you miss a credit payment, the cost of your debt increases. For municipal bonds, the rating might fall which prompts the municipality to offer ever higher rates to attract new investors for new projects. It also make it difficult to sell a bond like this before it matures.
Folks who can ride out the bond until maturity will not lose their money – at least we can assume this is the case. But if you believe this is possible, the research is up to you. Many business news sources do not report on municipal bonds. But local news sources do and investors should take an active interest in what is happening locally, particularly if they have a financial stake in the project.
If they do uncover the potential for a problem, be it current or in the future, the best thing you can do is sell the bond at a loss. This is more difficult if you are invested in a mutual fund that holds a wide variety of bonds. Of course you can sell the bond mutual fund if you suspect there is trouble on the horizon. But your fund manager should be well aware of these problems before they become yours – which is why you may have invested in a mutual fund in the first place.
The real question is how much risk is in these bonds? It might be more than you suspect. Rising interest rates could stall the economy somewhat and make tax revenue projects fall short. This could increase the number of defaults on these bonds. According to Mitchell Savader, CEO of Savader Asset Advisors, a municipal bond–research firm in New York City “there might be 100 more defaults in 2010, out of some 60,000 bonds currently active”.
That’s a small but still worrisome number. But not one that is beyond your control. Do some of your own legwork on local investment projects. And do some reevaluation of your own financial standing in the process. If you believe you can wait it out until the bond matures (in other words you invested with money you did not need), then holding it would be the best option. But selling at a loss if you feel the risk has become out-sized for your conservative portfolio, waiting might only make it worse.
To see and hear more about these bonds.
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