UPTHINKING FINANCE

• [3:46] What drew Jonathan to the municipal bond sector
• [5:17] The difference between treasury and municipal markets 
• [7:17] What does limited liquidity with bonds mean?
• [9:18] What Jonathan looks for with individual securities 
• [14:22] Should insurance be a significant consideration? 
• [17:08] A conversation about municipality bankruptcies
• [18:54] Navigating managed portfolios through the Great Recession
• [23:40] Two things advisors look at in the treasury markets
• [27:40] How politics influence municipal bonds 
• [29:20] The impact of choosing municipal bonds 
• [34:00] Are municipal bonds a separate asset class?

The municipal market is always compared to the treasury market. It introduces a bit more credit risk relative to treasuries. There tends to be some liquidity (which you are compensated for) and they are typically tax-exempt securities. The coupon you receive in treasury markets is taxable at the Federal tax rate. Investors choose municipal securities over treasury securities for several reasons, such as additional yield and credit exposure. 

Over 50% of the marketplace is retail holders. They follow buy-and-hold strategies. When the market is going haywire and you need liquidity, it impacts your ability to sell the security. You have to wait for a retail holder to want to buy the security. 

But the treasury market is full of global buyers—institutional, retail, and government. One of the benefits of municipals is that they’re less volatile than the treasury market. We’ve seen that as international buyers have stepped away from the treasury market. 

There are distinct differences between municipal securities. A municipal bond is either a general obligation bond of a local municipality or a revenue-backed bond. If you’re looking at a general obligation bond, you start with both qualitative and quantitative factors. 

At a high level, you want to look at the governing structure, how consistent they are at passing budgets on time, budget performance, and socioeconomic factors of the municipality (wealth, unemployment rates, and where the revenue mix comes from). There’s a host of qualitative factors.

When you shift to quantitative metrics, it has to do with budgets:

• What budgetary surplus have they run historically relative to the total budget? 
• What does their balance sheet look like?
• What does the general fund balance look like relative to the overall budget?

When you look at balance sheet metrics, they’ve become highly important compared to income analysis. 

Advisors look at inflows and outflows. When they see treasury rates selling off and moving up, they tend to see outflows in municipal asset classes. Secondly, you can compare the yield on a municipal security relative to treasuries. Historically, anything inside of 20 years trades around 75% of a treasury yield. Municipal bonds may soften over the next couple of months as they catch up to the treasury market. 

They spend more time looking at the yield of a municipal security relative to a corporate security, especially going into 2023. Jonathan notes that we’ll see earnings compression, upticks in defaults, and an economic slowdown. When you look at ratios of municipal debt versus corporate debt, there is a historical mean that they look for around 70%. Things are landing in that sweet spot right now. 

Listen to the whole episode to learn more about the ins and outs of municipal bonds!

Jonathan Mondillo is not affiliated with or endorsed by LPL Financial or Capital Investment Advisers.

Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA & SIPC.

The financial professionals associated with LPL Financial may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state. 

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