Investment Guy

Several years ago the most desirable municipal bonds were AAA and insured.  In today’s muni-bond market, insurance ain’t what it was.  Many bond insurers are no longer reliable, and you need to know the quality of your bonds.

Here’s how bond insurance used to work:

Municipal bonds are issued by state and local authorities, many of which have average credit, at best.  In lieu of paying higher interest rates, there are Bond Insurance companies that allowed a municipality to ‘purchase’ their AAA rating in return for a fee, which is much cheaper over the long run than paying a higher interest rate to investors.  Thus, an A-rated municipality could buy insurance and issue bonds at coveted AAA-rated interest rates.

Unfortunately, these insurance companies got greedy, and started looking for more and more of those lucrative fees.  They began insuring Mortgage backed bonds as well, many of which were AAA rated by the rating authorities.  Now the same mortgage bonds are known as ‘toxic’ investments, and the insurers obligations are beyond anyone’s comprehension.

What this means for your Muni bonds:

Your bonds are only as good as the municipality’s underlying credit quality- their own ability to pay back your bond.  This often depends on the municipality’s revenues from tax receipts.  And we are beginning to see much lower tax-revenues in the current economic environment.

Many of the bonds you own that were once AAA rated and insured are now neither AAA nor insured, through no fault of the specific municipality. 

Any municipality that was already AAA quality did not need bond insurance.  Therefore, any bond that was insured was most likely not AAA underlying.  If your bonds are insured you need to take a closer look, and get to know your bonds.  Now is the time to upgrade the quality of your portfolio.