Bond insurance is a form of insurance policy purchased by a bond issuer to ensure that the principal and all associated interest payments are made to bondholders in the case of default. Bond issuers will purchase this sort of insurance to improve their credit rating, lowering the amount of interest they must pay and making the bonds more appealing to potential investors.
What percentage of muni bonds are insured?
For one thing, according to Bob DiMella and John Loffredo, co-heads and co-chief investment officers of MacKay Municipal Managers, the initial analysis of muni defaults was done at the height of Covid-19 shutdowns in March. In the meanwhile, not every market niche has been squeezed. Public utilities have fared well, and public schools should profit from the housing market’s sustained strength. Pension plans, on the other hand, have benefited from the rising stock market.
Municipal bonds with an insurance wrapper, however, may be worth a closer look for many investors, particularly those who buy and hold individual bonds.
“It’s a belt and suspenders bond,” DiMella explains. “You have the underlying credit, as well as this financial guarantor as a backstop.”
Bond insurance, as the name implies, ensures that the principal and interest on a municipal bond be paid if the issuer defaults. Before the financial crisis, DiMella notes, such insurance was widely employed, with a handful of companies insuring around 60% of all new municipal bond offerings.
“After the crisis, it literally plummeted off a cliff,” he says, with insurance wraps accounting for a miniscule percentage of the market.
Insured municipal bonds had been slowly resurgent in recent years, but the Covid-19 outbreak has sparked renewed interest, with insured munis accounting for roughly 10% of new muni bonds. To assuage investor concerns about rating downgrades and defaults, more major and high-quality issuers are including an insurance component in new bonds. Most bonds are now insured by two companies: Assured Guaranty and Build America Mutual.
Investors gain from stable ratings, better liquidity, and lower volatility, according to Loffredo.
Of course, insurance is never free. For muni bonds wrapped with insurance, investors will often give up between 10 and 20 basis points (1/10th and 1/20th of a percentage point) of yield. While some investors may object at this tradeoff, particularly in a low-yield situation, buy-and-hold investors may find it well worth their money.
“You don’t have to give up a lot of yield to receive the benefit of stable cash flow,” Loffredo says, adding that high-net-worth clients and family offices have recently showed an increased interest in insured munis.
While municipal bond insurance is a low-cost option for investors who keep bonds until they mature, active investors may benefit from price appreciation.
“We would argue that there is far more value today than there was at the start of the year,” DiMella says. “They’re wider in many situations than they’ve been in many years.”
Almost every section of the muni market was hit when the market first went off this spring. Insured munis recovered faster than comparable bonds, although spreads for triple-B-rated insured munis are still greater now than they were at the start of the year.
In fact, the guaranteed index’s gap over 10-year Treasuries started the year at 20 basis points and quickly grew to 190 basis points during the spring market turmoil. They’ve now reduced to 99 basis points, but the spread is still wider today than it was before the crisis, implying that rates will fall and bond prices will rise.
Are municipal bonds a good investment in 2021?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
Can you lose money with municipal bonds?
These funds have a low risk of losing value, and the interest they pay is consistent. They also pay a very low interest rate as a result of their safety. Risk and reward are inextricably linked: a lesser risk equals a lower payoff.
Why are municipal bonds falling?
Some economists predict a reduction in muni demand this year due to a predicted slowing in household savings, which grew during the pandemic, particularly among the wealthy. The demand for tax-exempt debt has long outstripped annual issuance.
Opportunity cost
Municipal bonds’ tax advantages aren’t as valuable if you’re in a lower tax band as they are if you’re in a higher tax bracket.
If that’s the case, you could be better off putting your money into alternative investments for a larger return.
They may not be liquid
If you need money quickly, you should be aware that municipal bonds may have liquidity problems.
You might not be able to find an active market for your bonds, which means you won’t be able to sell them when you want at the price you want.
What is the difference between a bond and insurance?
Insurance is a type of risk management in which the individual or business being insured and the insurance provider enter into a contract. When a covered loss happens, the insurance policy promises that the insurance company will compensate the insured.
A surety bond is a contract between three parties: the principal, the obligee, and the surety firm that provides the bond (surety). If the principal fails to satisfy the contract’s requirements, the obligee can bring a claim against the bond to recover their losses from the surety.