Muni Bond Pricing

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BigFirepower's picture
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Joined: 2010-07-09

The clearing firm I'm with, is NFS, a division of Fidelity. Muni bonds on our system, reflect very weak pricing. In two months, I've seen many holdings decline between 10 and 17 pts. I've seen muni bond funds fall by relatively similar amounts.Like all bond busts, I'm frustrated that this "lose" part of the equation, doesn't have the corresponding "win" on the buy side. Simply put, I can't seem to buy these bonds at these low prices. Instead, there is just this huge sucker's spread. But, the silver lining I want to confirm, is that the open ended and closed end side is "priced" as NAV, the same way my NFS driven statements are reflected. Can anyone confirm this, I've asked many times over the last 20 yrs without a good answer!Bonus points..... Is there a "name" for the pricing standard?If you cannot post in a public forum, PLEASE, register and shoot me a "private message".   

anabuhabkuss's picture
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Joined: 2005-05-02

BFP,Do you purchase the bonds through fidelity's bond desk or another 3rd party?I clear through NFS, as well, and we're constantly asking our desk for information on how these get priced and I still don't understand it, tbh with you.Here's where my clients have a problem. They see their statement, see that not only have all their prices "dropped in value" but did so at nearly the same rate!Bond A: -2500Bond B -2470Bond C -2600I don't even have more than one holding within the same state! I have some clients that get it; that these prices are estimates and do not reflect what the market would ask for it should we put them out there, but others just see a negative and a big number that follows. 

BigFirepower's picture
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Joined: 2010-07-09

Well, certainly, if the client has been with you since 2007 or longer. All you say is, "just like last time, the system is showing some signs of volatility. More than likely, this is a buying opportunity. If you can't buy, for goodness sakes, don't do anything knee jerk and make a paper loss a permanent one."Now, Mr. Buhkisser, if you sold those bonds, without disclosing how volatile they can be, like SOME people you and I may or may not know, well...then you get to pay the piper....For all the newbies out there, and others here months ago calling bonds Nirvana, well, think again...Any account I have, regardless of age, that has less than 30% stocks, gets disclosures and an earful about bond market/inflation risk. So, it's their fault. This bond market volatitlity is no big deal, as long as there is decent equity exposure.

BondGuy's picture
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Joined: 2006-09-21

If you are buying individual issues for  income the recent effed up market  presents a buying opportunity( note the use of technical fixed income market speak to describe the market. Feel free to employ with concerned clients). For you asset allocators time to book some profits in the long long stuff, get it off the books for statement time,  and buy it back cheaper nxt year. Speaking of nxt year, tipping my hat to the ever brilliant Meredith Whitney, once the supply gets slurped up prices should firm and we get back to biz as usual. Speaking of Meredith Whiney, one smart chick. She was one of the first to see the stress cracks in the mortgage market. So, you've got to give her some cred. That, and from the looks of her, she's not missing too many meals. Concerns? Sure, Christie has it right, the credit card is tapped and the cheap bag of tricks is empty. That said, G.O. bonds and essential service, no worries.  

I am legend's picture
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Joined: 2010-03-04

On the other side of the pricing question is this anomoly.  I just bought some BABS for a client yesterday and they are all showing significant gains today.  I bought 4 different issues yesterday and they are all showing  being up 2-4%.  I have also called about this and have been told that we use a 3rd party pricing service which doesn't necessarily reflect the current market since they use pricing estimates for issues that aren't actively traded.  I am with WFA.

BondGuy's picture
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Joined: 2006-09-21

I am legend wrote:On the other side of the pricing question is this anomoly.  I just bought some BABS for a client yesterday and they are all showing significant gains today.  I bought 4 different issues yesterday and they are all showing  being up 2-4%.  I have also called about this and have been told that we use a 3rd party pricing service which doesn't necessarily reflect the current market since they use pricing estimates for issues that aren't actively traded.  I am with WFA. Call the BAB trader and get a bid.My firm has on screen pricing that is at least in the ball park of reality. That said, I know when I'm looking at an out of whack price.

newregrep's picture
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Joined: 2010-03-22

Here is my 2 cents, (more like negative cents since I'm a noob)We had a meeting about this today.  Everyone is up in arms about the muni market and screaming bloody murder about defaults.  As far as I'm concerned, I'm not too worried!  I think there still are great buys out there.  We just need to be more careful in our selection process.  I believe on a double A the default rate is 1/10th of a percent, and on a single A the default rate is 4/10th of a percent.  To me, that's a darn good bet!Along with this great safety, the yields are also higher than after tax-corp bonds, considering you are in atleast 28% tax bracket, so why not?I look at it this way, the future is so unpredictable.  Our research team has new opinions every 2 weeks and directions change so often.  This may sound wreckless but I feel comfortable going with yields that will provide the highest amount of income TODAY and deal with the consequences later (if there are any that is).  As long as I'm focusing on simple products like high quality munis, where the checks come semi-annually, and your principle is par at maturity, I do not have much to worry about.  

I am legend's picture
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Joined: 2010-03-04

BondGuy wrote:I am legend wrote:On the other side of the pricing question is this anomoly.  I just bought some BABS for a client yesterday and they are all showing significant gains today.  I bought 4 different issues yesterday and they are all showing  being up 2-4%.  I have also called about this and have been told that we use a 3rd party pricing service which doesn't necessarily reflect the current market since they use pricing estimates for issues that aren't actively traded.  I am with WFA.  Call the BAB trader and get a bid.My firm has on screen pricing that is at least in the ball park of reality. That said, I know when I'm looking at an out of whack price. I wasn't complaining about this since they are bonds I just bought for a client and they are showing significant appreciation.  I have no problem with this.  It's when they show a drop of 5 points right after you buy the bond that bothers me.

BigFirepower's picture
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Joined: 2010-07-09

Call me a cynic, or whatever, but those "historical default rate" on munis, is like driving your car while looking through the rear view mirror. If you sold all your stocks in early 2000, and just bought munis, the last 10 yrs or so would have been mostly pain free. You would have outperformed the stock market for sure. But, that is the last 10 yrs...Doing the oppositve of a ten year trend is generally pretty profitable. I certainly remember how negative folks were on conservative dividend paying stocks and muni bonds by 1999. Anyone that is a newby, would do their career an enormous service by studying the last 30-40 yrs of stock and bond markets. Just because you weren't there, doesn't mean you can't read about it, really study it. Then, when asked you could say "obviously I wasn't there, but that book shelf over there, all those books, I've read them...."An economist that bases most of his decisions based on history, is James Grant. I'm a big fan of his, have read many/most of his books. If I had the money flowing out of my pockets, I'd get his monthly newsletter, Interest Rate Observer. His books Mr. Market Miscalculates and The Trouble With Prosperity are two very informative and entertaining reads. Virtually every professional RR I know, NEVER reads books about finance and economics. That's pretty lame...Now that I think about it, FINRA should credit book reading as CE credits, and we'd certainly get more from it.

David, RR editor's picture
Joined: 2010-01-17

On my blog today I ask: How to position client portfolios if a wave of municipal government defaults is on the way?I suppose the simple answer would be to avoid buying munis or other municipal revenue bonds. But what would be the fallout? Meredith Whitney, famous for accurately analyzing and predicitng in 2007 the troubles that would befall Citigroup, now runs her own shop, Meredith Whitney Advisory Group LLC, with which she intends to compete against the big rating agencies. Anyway, she has calculated, according to today’s Lex Column in the FT, that a wave of municipal bankruptcies is in the offing. The Lex column quotes her as saying there is $6 trillion — that’s trillion — of total outstanding debt (including underfunded pension plans) in U.S. cities and states. That equals 2.5 times their tax base, Lex quotes her report. Put another way, that’s equal to about 40% of of the nation’s GDP. If she is right — that a wave of government defaults is on the way — how do you position your clients’ portfolios? Especially those clients in high tax brackets who rely on munis for income?

BigFirepower's picture
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Joined: 2010-07-09

Well David, clearly, a few months ago, it would have been prudent to make decent sized changes. Bonds to stock, long to short maturities, buy some gold/silver/precious metals funds. My shop did that. And, in case that sounds "made up", search for my post "bond bubble".Doing something about it now, is a great way to make a trade on a client, for your own benefit. The horses are out of the stables....And if Whitney is a "genius" for stating the obvious, tonight I'm predicting darkness. The only people that could not see dark times ahead for financials and r/e back in 2007, were the kool aide drinking foools. Seriously, didn't take a rocket scientist, only a reasonably educated professional that has some experience in bubbles, valuations and a penchant for being ahead of the game, not behind it. I'll admit, right now I can say I'd wish that I had done even more than I did last fall, but so it goes. Heck, by late spring or early summer bonds might be really cheap. All this talk about bankruptcy was just as valid in Sept as it is today, and anyone that thinks tax brackets for income later will go anything but up, are crazy. Tax brackets are a direct offset on munis, and at these prices, munis are at least reasonably priced. Try selling the stuff to some market maker right now is suicide, pricing is a joke. I love the idea that we finally see net inflows into equity funds, as we approach dow 12,000. NOW, folks have "decided" it is time to get back into equities, because they "feel better", and things look like they are getting better. Ha ha, great, give me a few more percent upside from here, and I'll give you all the large cap stocks you want....Frankly, I'm glad that bonds and stocks quit correlating, should give a person a place to go to when the dow is at 12,200-12,500. In moderation, of course... 

BondGuy's picture
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Joined: 2006-09-21

David, RR editor wrote:On my blog today I ask: How to position client portfolios if a wave of municipal government defaults is on the way?I suppose the simple answer would be to avoid buying munis or other municipal revenue bonds. But what would be the fallout? Meredith Whitney, famous for accurately analyzing and predicitng in 2007 the troubles that would befall Citigroup, now runs her own shop, Meredith Whitney Advisory Group LLC, with which she intends to compete against the big rating agencies. Anyway, she has calculated, according to today’s Lex Column in the FT, that a wave of municipal bankruptcies is in the offing. The Lex column quotes her as saying there is $6 trillion — that’s trillion — of total outstanding debt (including underfunded pension plans) in U.S. cities and states. That equals 2.5 times their tax base, Lex quotes her report. Put another way, that’s equal to about 40% of of the nation’s GDP. If she is right — that a wave of government defaults is on the way — how do you position your clients’ portfolios? Especially those clients in high tax brackets who rely on munis for income? The short answer on how to position clients in the current market is carefully. Know the entity in which the money is to be invested. This means looking long and hard beyond the Moody's and S&P ratings. Or, having a bond analyst who can do it for you. The negative headlines are driving down prices and creating opportunities in well managed municipalities.That said there are some points to be made here:1. With regard to Muni specialist, Meredith Whitney's 60 minutes interview didn't lay anything on us that we didn't already know. Things suck out there, and they've sucked for a long time. Depending on your POV and the client's risk tolerance it can be viewed either as a problem or an opportunity. 2. Meredith may be overstating the risk. States can't declare bankruptcy. However, they can run out of money. Illinois is out of money right now. Yet, the debt is still getting paid. How? No matter how bad things get there will always be money coming in. States low on money must shuffle their priorities, pick which bills get paid and which ones don't with the cash they do have.  Debt payment gets moved to the front of the line because not paying the debt will hinder the State's future abilty to borrow. Not being able to borrow will only make the situation worse. Much worse! Lacking access to cash would suffocate a state capping any ability to climb out of the hole. For this reason I believe the likelihood of a default at the state level is improbable. 3. Muncipalities unlike corporations can't declare bankruptcy and then reinvent themselves under a new name. If they declare bankruptcy they must face their debt holders. Those debt holders are first in line to be paid, ahead of all other creditors. If the bond is connected to a specific asset they can force the sale of that asset or if a redevelopement project force the town to live with a big gaping hole in the ground until they get paid.  Non payment of bondholders hinders access to capital markets leaving the municipal entity with no access to future funding. Because munipalities have no other way out they are forced to negotiate with bondholders. Orange County California is a case in point. The muni manager there was a man ahead of his time in misusing derivatives to drive the county to bankruptcy. Three years later the bondholders were paid in full, interest and principal. Scary, yes, and not an experience any investor wants to be faced with, yet, a great example of how things can work when the worst does happen.4. Speaking of California, constitutionally the state debt get paid second only to education. That means before a single state employee gets a paycheck or a pension check the debt service has to be paid. So, lots of incentive to get the cash reshuffling in the right order.5. Municpalities will find a way. A way to close their deficits. The days of smoke and mirrors and right pocket left pocket are behind us. It's time to pay the piper. How? Look no further than Chris Christie governor of NJ. He's tackling the problem on every level. He cancelled a 6 billion dollar tunnel project, in the process giving up the biggest federal handout in history of cash for a public works project. Jersey couldn't absorb the estimated 3 to 5 billion in cost overruns. He's confronting the two biggest state labor unions in the state, the teachers and the state workers. He's asking for concessions that will close the pension funding gap. He's changing the state's supreme court by not granting automatic reappointment of judges. Why? Mostly it's about the Abbott Districts. 30 years ago the state supreme court mandated that the state's 26 poorest school districts be funded at the same level per student as the state's wealthiest districts. And Jersey has some of the wealthiest districts in the country. 30 years later this well meaning program to bring quality education to poor children is an abysmal failure. Test scores are no higher today than they were 30 years ago. Dropout rates are higher, and post secondary education rates have not changed. Turns out poverty is the problem, not education dollars. Yet, the do gooders insist on throwing more money at the problem. Right now more than half of every education dollar spent in NJ is spent in these 26 school districts. That's billions of dollars every year!! The other 577 school districts in NJ split the remaining 40 plus percent thus making Jersey the highest property tax state in the nation. The only way to change this is to change the supreme court. Christie wants to stop the crazyness and is hoping to find judges who see it his way. Additionally, Christie is cutting state aid to all municipalities. These are a few of the examples of how one governor is facing the problem head on. Others will follow his lead. 6. Most retail advisors are ill equipped to guide investors in this environment. They've been trained to be asset gatherers not muni specialist. Many firms de-emphasized buying individual muni issues, cutting sales credits etc to lead advisors to the fee side. IMO, if we do get into a period of increased defaults the investors who will suffer most will be the clients of these advisors. 7. I give props to Whitney for her partially right call on the mortgage fallout. If Steve Eisman goes on 60 minutes saying the same thing, I'm packing my bags and moving to the moon. Will i buy bonds in the most affected states? Yup! Everyday! Just gotta know what you are buying. With any luck Whitney will come on and and say something else to drive down prices even more. If she's right, and we do get the defaults there will be lines of winners and lines of losers. Opportunity exists in reading between those lines. That's the value added of dealing with a specialist rather than a general practicioner. We can't eliminate the risk, but we can reduce it.     

BigFirepower's picture
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Joined: 2010-07-09

Awesome post BG. Didn't know point #4, good to know. Interesting well thought out comments about the schools. Did you hear about Detroit, buying 40k laptops from a foreign company, with US tax dollars? Ugh, before we go broke, we can start by not throwing money away. A laptop is just as likely to make a kid "smart" as a set of encyclopedias. Not likely, unless the kid opens it up and tries like the dickens to learn.

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