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Business

Alan Griffin: Considering Income from Municipal Bonds

The bond maze is enormous and can be intimidating, but help is available

Anyone in a higher tax bracket looking for an income-generating investment should consider municipal bonds.

Alan Griffin
Alan Griffin

The interest on most municipal bonds is not taxed by either the federal government or the state of issuance. There are thousands of issuers across the country, and California has the largest municipal bond marketplace.

The variety of maturities, yields, credit quality of issuers and bond structures is enormous and can be confusing and intimidating for those who are unfamiliar with the market. Fortunately, Crowell, Weedon & Co. and its Municipal Bond Department bring a wealth of experience to help investors navigate the maze. Investors can also turn to a number of online sources that provide financial information about issuers and the trading history of individual bonds.

As with any financial instrument, municipal bonds fluctuate in price. However, since most municipal investors hold their bonds to maturity, their primary concern is the interest payments they receive from their bonds. That interest will be determined by the bond’s maturity, the perceived credit risk of the issuer, the bond’s structure and the general movement of interest rates. Currently, short-term interest rates are low, but financial stress on many municipal issuers is high as spending obligations have increased with the recent recession while receipts have declined.

The yield curve is steep, which means the difference in interest received between bonds with shorter maturities and longer maturities is large. Historically, interest rates are low across the yield curve, which means that higher rates will result in a loss of market value — the longer the maturity of the bonds, the greater the loss.

We currently recommend bonds maturing from 10 to 25 years, to take advantage of the steep yield curve while providing some protection against market value loss due to an increase in interest rates. To address credit quality concerns, we recommend for the greatest percentage of a municipal portfolio essential service revenue bonds, rated A or better, such as the Los Angeles DWAP, the East Bay MUD, the Sacramento MUD, or the Metropolitan Water District or general obligation bonds with high ratings, good financials and low debt. Because credit quality spreads have dramatically widened, a small percentage of the portfolio can be devoted to lower quality bonds to capture yield. However, the investor must have a tolerance for price volatility and negative headline risks, and such bonds should only be purchased with money the investor regards as risk capital, in the same category as an equity purchase.

The Municipal Bond Department can help navigate the municipal bond maze. We are one of the most active, price sensitive and open‐to‐negotiation bond desks in California. Our veteran staff can answer your questions about credit quality, pricing, evaluating portfolios, building bond ladders, or working with the Tradeweb platform. Municipal bonds appeal to investors seeking tax-advantaged income, and can also open other doors into other investment products for these wealthy investors.

Disclosure: Municipal bonds, like other fixed-income instruments, are subject to change in market price based on factors including the level of interest rates, market conditions and credit quality of the issuer. Tax-free bonds purchased at a discount may generate taxable gains upon sale, call or maturity — please check with your tax advisor. Not FDIC insured, no bank guarantee, may lose value. Partners at Crowell, Weedon & Co. may have a position in this security.

— Alan Griffin is branch manager and partner of Crowell, Weedon & Co., 111 W. Micheltorena St., Suite 200, in Santa Barbara. Click here for more information or call 805.618.3160.

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