Tuesday, August 18, 2015

Review of Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income Hardcover by Triet Nguyen

With federal, state, and municipal governments planning to borrow to cover their operational and pension shortfalls, it's always worth thinking about distressed government credits, and Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income is a respectable effort. Some notes:

  • "One can make the case that there is not one but two separate tax exempt markets. On the one hand, there is the traditional municipal market with its extremely low default rate, buttressed by strong, time-tested legal protections (at least for now). On the other, there is the tax-exempt high yield market, which is municipal in name only and which displays the much higher risk and default characteristics of private entity or corporate borrowers. [...] As a further observation, most of the problem credits have historically occurred in two broad categories of risk: real estate and health care."
  • "[T]he best time to have maximum exposure to high yield is when the economy is coming out of recession and credit spreads are at their widest. As the business cycle gets in full swing and rates start to rise, credit spreads will tend to narrow to a point where higher quality paper becomes a better relative value. At that point [gradually] improve the average quality of the portfolio..."
  • "The collapse of the bond insurers in 2008 and 2009 has created a new opportunity for the credit investor: an entire class of formerly insured issues who never obtained a rating on their own. [...] Sorting through the underlying credit quality of these individual issues will surely produce some interesting values..."
  • "Revenue bonds might on the surface seem riskier than general obligation bonds because the revenue bondholder faces the risk of project failure and lacks recourse to general municipal receipts... However, changes to the Bankruptcy Code in 1988 established rights of a revenue bondholder in Chapter 9 that are actually more favorable... [General] obligations are subject to negotiation and restructuring under the plan of adjustment..."
You may recall from The Fundamentals of Municipal Bonds that the "innovative" types of municipal bonds - e.g. revenue bonds that pledge revenue, or special financing districts - were developed partly as a way to dodge the voter approval requirement. A way of forcing additional debt on unwilling voters.

I would add that the two separate tax exempt markets may further subdivide. While the category of poor credits used to be ones that were "municipal in name only", we now see municipalities that were captured by public workers that are unable to service their debts. And out of the three sides that need to compromise - taxpayers, former workers, and bondholders - most of the compromise has been coming from bondholders!

So, municipal bonds are a category where lots of money is going to be lost. That is to say, a category currently comprised of a great deal of illusory wealth. 


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