Municipal Bond Forum

Although we regret having offended you, we respectfully submit that you are overlooking some significant factors in regard to this offering.

The bonds to which you refer are rated “AAA” by S&P because they are insured by FSA. The purpose of bond insurance is to serve as a remedy for the potential bankruptcy to which you refer. 

As municipal bond specialists, we are quite familiar with the plight of Jefferson County and its beleaguered sewer authority. 

Though not for everyone, there are many astute investors who are pleased to take advantage of a short-term “AAA” bond that is priced to reflect the inherent risk. These investors are counting on the financial wherewithal of FSA and Assured Guaranty to ensure payment of principal and interest.      

Most municipal bonds contain security pledges that place payment of the debt as a first lien on revenues received by the issuer. This may not be universally true, but holds for both general obligation and revenue bonds. This structural priority of lien is partially responsible for the low default rate for municipal bonds and their wide popularity.  How this structure is implemented varies from issue to issue. To determine the exact methodology used in a specific issue, investors need to review the Official Statement accompanying the issue where the security provisions of the bonds are described. Rating agency reports released at the time of issuance also describe the priority of debt service payment lien since this is a principal rating factor.

We are not aware of anyone who has been able to successfully predict the direction of interest rates for any reasonable period of time. 

Long-term municipal bonds are purchased for the tax-free income they provide, with the understanding that market values will fluctuate. Most bond investors employ a buy-and-hold strategy and rarely sell their securities, making the value of their holdings irrelevant. A good example of this was evidenced a year ago when the Wall Street meltdown precipitated a dramatic decline in the value of all tax-free bonds. Today, most bond prices have completely recovered from that swoon.

Although the current economic environment of no or slow growth, high unemployment and low inflation are not traditionally the ingredients that produce higher interest rates, there are no guarantees. The only thing we can predict with any certainty is that over the long haul, interest rates will rise and fall.

For these reasons, we continue to recommend only investing funds that are available for the long-term and maximizing your income on every purchase. 

This additional income, not available on short-term bonds, will enable you to ride out interest-rate fluctuations, which are inherent in every business cycle.