Municipal Bond Risks: Default Vs. Bankruptcy

Best of the Bond Market for March 15th, 2012

Tweet and Article by @cate_long

Does Default Equal Bankruptcy?  Our Take: Cate gives a great overview of the big difference between a municipal bond default (where a municipality misses a debt payment) and a municipal bond issuer bankruptcy (which requires a court order and as Cate states in her article is the “end of the plank”).  The bottom line here is that just because a municipal bond defaults does not mean that the bondholders will not eventually be paid, and even in bankruptcy municipal bondholders may still receive a portion of what they are owed.

Article by Bond Buyer (Found on Muni Snaps)

Muni Holders fall to 2 year low Our Take: John Mousseau’s quote from the article pretty much says it all – “We know that bond fund flows turned around at year-end 2011 — but not enough to make up for the total bloodbath that the Whitney debacle caused in early 2011,”   While muni bond defaults did rise in 2010 and 2011, they went from an average of 2.7 a year to 5.5 per year which is no where near the amount of defaults Meredith Whitney was predicting and a very small number indeed for a $3 Trillion + market.  Unfortunately investors who were scared out of the market by Whitney missed out on some great returns.

Tweet from @TaylorRiggs_BB

Mun-Treas ratios way below 100% now. 5yr ratio fell to 80.2% from 86.8% at the start of the week. Our Take: The Muni-Treasury ratio is a comparison of the yield on a AAA rated municipal bond with a treasury bond of the same maturity.  Before the financial crisis the ratio was normally below 100% reflecting the advantage that the tax free municipal bond had over the treasury and therefore the lower yield.  Since the financial crisis, and the intervention by the Fed that soon followed, municipal bonds have often yielded more than the comparable treasury.  This made municipal bond very attractive as in addition to getting a comparable yield to the treasury you also got the extra juice from the tax exempt status of the muni bond.  After the recent runup in yields in the treasury market however the ratio has fallen, reflecting the fact that treasury yields have increased by a greater amount than comparable munis recently.

Tweet and Article from @dlevineMW

Corporate Bonds Benefit from Fed Too – Our Take: Investors are moving money out of Treasury Bonds and into riskier investments causing treasury yields to rise.  Deborah shows us that Corporate bonds have been one of the beneficiaries of this, as the spread (the difference in yield) between treasury bonds and investment grade corporate bonds of a similar maturity has in the last 6 months declined from 2.6% to 1.94%.  This means that corporate bond rates, as with muni bond rates, have not risen as quickly as treasuries.

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