(For a video version of this demonstration, click: Non-Rated Insured Municipal Bonds - More Smart Money Techniques)
If you were presented with two different bonds with the same credit characteristics and the same length of maturity, but Bond A was yielding 4.5% and Bond B was yielding 5.5%, which would you choose? Bond B of course.
Now, if Bond A (4.5% yield) had an A rating and Bond B (5.5% yield) simply did not have a rating, would you still choose Bond B? If you're not sure, keep reading...
Non rated insured bonds are municipal bonds that were originally issued with high quality "insured" ratings due to insurance that guaranteed their issue, but no longer carry a rating due to a downgrade of the insurance company that guaranteed their bonds, and a subsequent withdrawal of the "insured" rating altogether.
Despite the lack of a rating, many of these bond issues have high quality credit characteristics.
Knowledgeable investors interested in generating the maximum amount of income while maintaining a high quality bond portfolio seek out these valuable bonds. We are often able to find non-rated, insured municipal bonds that offer up to 100 basis points more yield than similar quality bonds that have a rating. 100 basis points difference in yield translates to an extra $10,000/year of income per $1 million invested. Over ten years, that equates to an additional $100,000, not including compounded interest.
The first and most important thing you need to understand is that non-rated does not mean risk, nor does it mean high quality. Non-rated simply means the bonds do not have a rating.
It is also very important to understand that the bond insurers did not lose their AAA ratings from exposure to municipal bonds. They lost their ratings due to exposure to collateralized debt obligations and mortgage backed securities. When issuing these bonds originally, many municipalities and political subdivisions did not apply for an "underlying" rating. Instead they opted for insurance which allowed their bond issue to come to market rated "AAA" in many cases. The high rating of the insurance company lowered borrowing costs while the insurance was a tremendous marketing feature. Paying the rating agencies to analyze and rate their credit quality became an unnecessary expense for many financially strong investment grade issuers.
Municipal bond insurers have very high standards and stringent requirements. When analyzing the credit quality of an issuer the insurance company must determine that a future claim is very unlikely. In essence a municipal bond insurer will only insure a bond that has good fundamentals in terms of its ability to pay, since if the issuer fails to pay, the insurer is liable for the timely payment of both principal and interest.
Simply put, muni insurers only insure muni bonds they believe will pay after concluding a rigorous underwriting process. Now more than ever knowledgeable investors realize a "Non-Rated" insured bond, in most cases, is a quality bond and a great value. A bond issuer or borrower's inherent ability to pay is not impaired when the bond insurer loses it ratings.
Individual investors are well positioned to take advantage of these smaller unrated issues, as they often cannot be purchased by a large segment of institutional buyers who have rating criteria as part of their investment policy.
To take advantage of the value and additional income that non-rated muni bonds offer, it is essential for investors to be in contact with the proper guidance, expertise and research. I would encourage you to seek out a municipal bond specialist.
Investing in municipal bonds involves risk, including market fluctuations and potential loss of principal. This has been produced solely for informational purposes and is not to be construed as a recommendation of any particular investment or investment strategy. It is also not a solicitation or an offer to buy or sell any securities or related financial instruments. You should consider consulting a broker or investment professional before investing or implementing any investment strategy. The preceding presentation is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.