States, cities and counties across the United States are taking longer to file regular financial reports, leaving bondholders in the dark and adding to price pressure.
Last month, S&P Global Ratings withdrew ratings for 30 cities, counties and municipalities because they had yet to file their 2020 financial statements. According to analysts, the ratings agency placed New Orleans on credit watch for late reporting.
Although the municipal bond market is not as volatile as the equity or futures markets, investors should continue to monitor bonds after they have been purchased. Aside from a few high-profile defaults, investors should also be aware of smaller changes such as credit and liquidity risk, which can affect how they build and manage their overall portfolio.
Why Should Municipal Bonds Be Monitored?
Before purchasing municipal bonds, most investors conduct due diligence by evaluating the issuer’s financial health as well as the bond’s specific characteristics. Using a tool like Bond Screener can help you find the right municipal bonds for your portfolio. But despite potential changes in risk over time, many investors fail to monitor bonds once they become part of their portfolio. As a result, these modifications can have a significant impact on the overall risk of their portfolio.
Among these evolving risk factors, investors should monitor changes in:
- the issuer’s financial condition, given its impact on their ability to make interest and principal payments on time.
- interest rates that have an impact on the value of a bond in the secondary market.
- a bond’s credit rating that has an impact on its valuation.
- the bond’s liquidity due to a variety of factors that impact an investor’s ability to sell the bond and/or the ease with which the bond’s value can be determined at any given time.
If a bond defaults, investors should review the indenture in the bond’s official statement, which contains bondholder rights and remedies, and monitor the bond for ongoing disclosures about its repayment plans. In these situations, it is often best to work with a qualified financial advisor to ensure that your rights are enforced.
There are several ways to stay current on these changing risk factors. BondView, for example, makes it simple to access official bond issuer information and to keep track of your portfolio’s gains and losses. The portfolio tool allows you to create and manage one or multiple bond portfolios. You can also view BondView’s estimated prices, coupon, maturity date, accrued interest and ratings.
What Metrics To Track
The issuer’s financial condition and the bond’s liquidity are the two most important risk factors for investors to monitor.
The financial condition of the issuer can be monitored in two ways:
- Disclosures from the issuer
- Credit ratings from third parties
While credit ratings are simpler to understand, they are not available for all bond issuers and may not be updated frequently enough to cover all risk factors. This means that investors must also adhere to disclosures.
The three most important things to regularly keep an eye on are:
- Official Statements: The official statement informs investors about the issuer’s financial condition and risk factors. It also describes the bond’s terms and features. It’s a must-read before purchasing a bond and a valuable ongoing resource. Click here for more information on official statements.
- Future Disclosures: Continuing disclosures provide essential updates on the issuer’s financial condition and specific material events that occur after the bond is issued and can affect key bond features. It’s a must-read for investors who want to stay on top of current risks. Continued disclosures are discussed further here.
- Credit Ratings: Credit ratings represent an analyst’s assessment of the likelihood of timely repayment of principal and interest, as well as the likelihood of default. Credit ratings can change at any time and may not reflect the issuer’s and/or bond’s current condition.
The secondary market trading activity of a bond can be used to determine its liquidity. In addition to determining the value of a bond, this trading activity indicates how easy it would be for an investor to sell a bond before it matures. Even investors who do not intend to sell should consider liquidity risks in case they do need to sell.
Price discovery tools can assist in valuing bonds that do not trade on a regular basis by locating and comparing the prices of other bonds with similar characteristics.
Municipal bonds may not be as volatile as stocks or futures, but that doesn’t mean investors should ignore their bond holdings. It’s critical to stay on top of any changes in an issuer’s financial condition or bond characteristics that could impact investment risk.