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Buying the Yard Sale in Munis

01/16/2012 10:51 am EST

Focus: BONDS

Neil George

Editor, Profitable Investing

Two high-profile recent bankruptcies have sweetened the yields on many rock-solid municipal bonds. Buy these three funds to profit, says Neil George, editor of By George.

Neil, when we saw Harrisburg, Pennsylvania, file for bankruptcy—the state capital—was this the big muni collapse that Meredith Whitney was warning about?

Well, Karen, the key thing to look at is that the ongoing procedures are still very much in flux. But the idea is that Harrisburg is having to go through some sort of extreme measures to offload what was a very bad bank deal that was done in the city.

It’s also been joined by Jefferson County in Alabama, which also sort of sold a bill of goods by some of the investment bankers trying to take advantage of, let's say, some of the public officials that really could have, should have known better, but didn’t unfortunately. Therefore, the idea is that they are sort of paying the price now.

Really what we need to look at, Karen, is not the idea that this is going to represent a string of failures, but they really are very unique situations. In Harrisburg, it was a particular green energy project that unfortunately was tied into general revenues as a backup. Therefore, the bankers basically knew that they had a little more protection, even though the deal wasn’t going to make sense.

Jefferson County was another example in which they were sold a series of interest-swap transactions, in which the actual county council and so forth really needed to have a few extra MBAs on board with their slide rulers in order to figure out what they were actually getting into. Unfortunately, what was done is done, and therefore they are having to deal with it.

To answer your question about the big prophecy, are we going to be seeing hundreds of billions of dollars worth of bankruptcies? Not going to happen, hasn’t happened, and in fact, Karen, looking back during the last few years of all the financial shenanigans, as well as shenanigans over the last several decades, going back to 1980, we’ve only had about 48 major bankruptcies in this country.

And if you look at the municipal bond market and the recovery process for investors, typically the recovery process is 90% to 100% of actual assets. So individual investors and institutional investors that are in the muni market—even during the bankruptcy process—really end up getting their assets back at a multiple of what happens in the corporate world. We’ve had more corporate bankruptcies, and recovery typically tends to be either pennies or dimes on the dollar.

Therefore, where I’m going with this, Karen, is the idea that the municipal market is really providing a great opportunity. Ignore the headlines, ignore the hype, and instead look at the pay dirt.

Most communities, most states, and so forth throughout the US are more than capable of being able to service their debt. They’re making severe cutbacks in payrolls, they are basically making changes in tax policy, and in fact tax rolls throughout the US have been on the ascent for the last several quarters. Therefore, the capability of servicing their debt is doing quite well.

So look beyond the headlines and invest with confidence.

I think the key thing to look at is when you’re looking at the municipal bond market is that things have been sort of pushed down in yield, and because of the fact that people just didn’t know what was going on, there’s been a lot of hype.

Therefore, we also have been seeing a problem where a lot of issues had insurers—in other words, financial companies would say that if a state or if a municipal community didn’t make good, we would step up and make good.

The problem with that is that with the financial meltdown of 2007 and 2008, a lot of those insurers effectively lost their AAA ratings, or had to go through some reorganization themselves. The end of all this is that insurance really isn’t worth as much as it should be, and the reality is people starting to look at what the underlying credibility of the actual borrowers are on the municipal market.

Therefore, there is a lot of quality out there, if we were to focus on the muni bond markets of issuers that can pay their bills, have paid their bills, and will pay their bills without having to deal with some of the additional gingerbreading that happens with insured issues and so forth.

Very quickly, Neil, do you have any picks for us?

Three closed-end funds. One is the AllianceBernstein Muni Fund (AFB), another one is the BlackRock Muni 2 Fund (BLE), and the third is the Nuveen Quality Income Fund (NQU), and again I haven’t been buying them, but I am looking to add them to my own portfolio.

Related Reading:

A Muni Fund for Preservation and Income
What Happened to the Muni Meltdown?
Keep Your Bondholding Productive

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