Why Financial Guarantee Insurance Failure is Less Harmful than it Seems to Municipal Bonds

Reader Question:

Hi David,  I really enjoy your blog very much.  Your recent post regarding AAA bonds brings up a question for me and I’ve seen several different answers in the press and on TV.

 

I have about 35% of my portfolio in triple AAA muni bonds–most insured, but not all.  My intention with insured AAA bonds was to not have to worry about them.

 

I’m now reading about the potential bankruptcies of the muni insurers–AMBAC, etc.  I heard on the tube today that “we will see a muni bond crash” if the ratings on these insurers are lowered.  After the close I saw where one was lowered to a AA rating.  This is not what I like to hear and I suspect with further reading that the comment was overblown, possibly irresponsible. 

 

I hold my bonds to maturity with my principle concern of income generation. Is this something one should be worried about?  Anything specifically about the individual bonds that should raise read flags?  As I live in Arkansas, most are Ark. munis although I’ve got some from Puerto Rico.  Thanks for any insight on this.  And keep your great posts coming.

I don’t think you should be very worried.  Municipalities rarely default.  When they do default, it is typically for a little while, and then payment resumes.  So long as a municipal bond has an economic purpose behind it — a necessary city, county, state, or project, defaults are rare.

The financial guarantee is a way of making the bonds thought-proof.  Bond mangers don’t have to do credit analysis; the guarantee is enough.  The guarantors aren’t dumb (at least with respect to municipals), they know what doesn’t deserve a guarantee.

Without knowing exactly what you own, I can’t say it with certainty, but I can say it is likely that you will come out okay if all you hold are munis that have an economic purpose.   (Be careful on the Puerto Rican issuers, I know little there.)  That said, the market value of your bonds have likely declined a little due to the possible loss of insurance protection.  If you are truly, buying and holding economically necessary issuers, you should end up fine.