US Treasuries are a joke and frankly worthless as long term income in our opinion. Ten year bonds paying 1.48% would be a misprint in earlier times now it is a reflection of broad ignorance of the perils of bond pricing and the sheer fear that an Obama economy makes of savers. Of course European savers are helping push Treasury rates down since fear is rampant over there due to being a few years ahead of the US on the out of control social spending curve. The sad fact is that when all this fear finally breaks either due to a better economy under a different US administration rates are likely to move up making any bond purchased now lose significant capital value and the very low interest rate worth much less. Owning a US 10 year US Treasury paying 1.5% and having interest rates move up just .5% the holder could lose 33% of the value in their bond. A $1000 bond could be valued at $667 with an annual payout of $15. This kind of risk is more than owning a 4% blue chip stock.
Municipal bonds which have been a staple of our portfolio for many years are also starting to bite in a different way due to the lower rateenvironment. For many years it was fairly easy to find good AA revenue municipals paying 5%. Our portfolio has many of these and some even 6% or better. However with the lower rates many borrowers are taking advantage of rates by calling bonds when allowed and reissuing them at the lower rate. As a bond investor that hurts since one has to take the capital and reinvest it in new bonds paying lower rates. We had two 5.5% A rated hospital bonds called this month and the best alternative we could find were AA rated 4.0% bonds as a replacement. Ouch
This is being repeated with regularity now in our portfolio, which if it continues for the entire bond portfolio would push down income generated with the same capital by likely 20%. Such are the perils of owning bonds which have call features. The good news is that even with the redemptions we are finding good AA bonds paying in the 4% range. Even better news is that the new bonds are priced right, either at par or sometimes just below. As has been our pattern for many years we will not buy bonds that are generally priced at 102 or above. The belief is that bonds priced higher than par guarantee a loss when redeemed and you end up giving back much of your capital just to gain the higher rate. Bonds bought below par not only make for capital gains, but also push up the coupon rate nicely. Of course YOU gain capital when and if the bonds are called.
Buying individual municipals means one must do research on your purchases and keep up with news on the issuers bond ratings. Fortunately in North Carolina that is easy via several web sites. North Carolina also has many issuers who are strong financially and there are a good number of state laws that keep bonds issuers in line. For instance the certificate of need that almost all hospitals must gain prior to being built make sure that if the hospital authority issues bonds there is shown to be a need for the beds being added to the area. That frankly keeps competition down and prices up, but significantly improves the ability of the authority to issue bonds at a higher rating and lower rate. Taxpayers gain, but hospital customers lose since that is a manipulation of a free market.
Hospital bonds known as revenue bonds offer compelling rates in NC as well as good value and sometimes gain AA ratings. The bond mentioned earlier that we bought for 4% was a AA bond for a hospital authority in NC that has very strong financial's and a vibrant market in which to operate. Bottom line is that municipals issued in states where finances are solid even at today's rates offer compelling values as compared to US Government Treasuries.
Of course 4% municipals are totally state and federal income tax free and would compare to 5% or higher rates on other income opportunities when including the tax free advantage. One thing that many people fail to consider when earning tax free income is that the lack of inclusion of the that income in your overall income when considering taxes owed actually reduces the tax rate on your other income by keeping it in lower tax brackets. In all municipals continue to be a great sources of income and we continue to recommend them for investors as a way to salt away your money.
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