Know-how guides 'muni' investor
They survived the financing problems of New York and Cleveland in the 1970s, but can municipal bonds so easily weather the tribulations of Whoops? That is one question being asked by brokers, government agencies, and investors as the municipal bond market tries to sort out the fallout from the $2 .25 billion default of nuclear plant construction bonds sold by the Washington Public Power Supply System (WPPSS, also known as Whoops).
Before that default, the principle of guaranteed payment of municipal bonds was considered nearly inviolate. As a secure place for a person's savings, the municipal bond almost ranked up there with US government securities. When a bond was purchased, the investor knew - or thought they knew - it would automatically generate semi-annual checks for as long as 30 years.
But in the wake of the WPPSS default, many investors are wondering just how safe municipal bonds are. One result of this uncertainty has been a big increase in the demand for insured municipal bonds and insured municipal unit trusts, or pools of insured bonds. One firm reports insuring $3.3 billion worth of municipal bonds in the first six months of this year, or 33 percent more than it insured in all of 1982.
Buying insured bonds seems to be one way investors are protecting the savings they have in ''munis.'' But for the experienced investor who is willing to give up some yield in exchange for security, the standard way is still recommended most often: Just buy the highest-grade bonds you can, sticking to triple-A or double-A bonds, issued by agencies or municipalities that have a good record of making their semi-annual payments.
Insurance, after all, is only as good as the company issuing it. And in many cases, the municipality may be more financially sound than the insurance companies.
People who have bought bonds recently, particularly since July 1, have noticed one change that has nothing to do with their security, but has a lot to do with the Internal Revenue Service. One of the provisions in last year's Tax Equity and Fiscal Responsibility Act required all municipal bonds to be issued in registered form. This means bearer, or coupon bonds, which were kept by the investor with no record of ownership at the brokerage or the issuer, have begun to fade out of existence.
Now, people will no longer clip coupons and take them to the bank to deposit or receive cash. Instead, the investor will simply be sent a check twice a year, and records will be kept of who owns what bonds, making it harder for people to avoid inheritance taxes through anonymity.
Outstanding coupon bonds, of course, will still be valid and their coupons will be honored. In fact, many municipal bonds were issued just prior to the July 1 deadline, sometimes at a premium, to investors who wanted coupon bonds.
For some bondholders, there are additional changes going on they may not like. One of them is the trend of bond issuers to ''call in'' their bonds several years early. Some of these bonds may have been issued when interest rates were 14 or 15 percent. With rates 4 or 5 points lower, these issuers are redeeming the higher debt as fast as they can. So instead of 30 years of income, the investor may find the bond called in after just four or five years.
The bonds most likely to be called are those issued by state or local housing authorities that issued bonds at 12 to 14 percent to raise money for moderate-income and first-time home buyers. But many of these homeowners have since refinanced their mortgages at lower rates, leaving the housing agency with a long-term obligation without enough monthly mortgage payments to back it up. So the bonds are called in.
One way individuals can protect themselves in this situation is to read the fine print on their bonds to see if they are callable. Some are callable anytime, others after five or 10 years. If they are, your broker can tell you if your bonds are among those recently called. Although issuers run ads in the financial press listing callbacks, these can be easily missed.
The callback notices can also be missed by the bank, which will continue to redeem your coupons until it finds out about the action. Then it will require repayment from you, and this usually ends up coming out of the principal.
In the future, another protective measure would be to buy bonds that are noncallable or have long-call provisions, like 10 years or more.
One reason for all these early bond calls, some experts suggest, is the increased insecurity mentioned earlier. As municipal bonds become less secure - or are perceived to be so - their prices have become more volatile, particularly since the Federal Reserve Board's October 1979 decision to reduce its efforts to influence interest rates.
If this volatility bothers you and you do not want to commit yourself to a long-term investment, you are probably better off in Treasury securities with 6- to 12-month maturities. You may give up a percent or two of interest, but you won't be trying to outguess the future course of interest rates and inflation.