We recently had a taxable municipal bond called away from us as the issuer finally retired the debt. The issue was the Atlanta and Fulton County 7% due in 2028. Cumberland first began buying this bond in 2004, since we liked the defensive characteristics of this particular security. While the bond had a long final maturity, it had a very high coupon rate and a call option attached to the bond that gave the issuer the right, but not the obligation, to retire the debt at a specific price. Given the economic outlook at the time, we felt this bond would be called away from us in 2006 or 2007. This would accomplish our goal at the time of maintaining a short- duration bias, as the Federal Reserve had short term interest rates pegged at the historically low (at that time!) one-percent Fed Funds rate.
Over time we accumulated what we could in the secondary markets. We liked the credit on a stand-alone basis. Not only were the revenues of the arena securing the debt, the city and county were guaranteeing their payments as well. The issuer’s underlying rating was watch-listed for an upgrade by S&P from AA-minus, while Moody’s had a AA rating and a stable outlook for the credit. Additionally, it was insured by Assured Guaranty, the only bond insurer today that is still writing new business.
This bond began to trade as if it were going to be called any day, hovering near the call price and generating close to 7% on a current-yield basis. That was a tremendous spread over Treasuries at the time for a bond with that credit quality. As the credit crisis began to unfold in 2007 and markets unraveled in 2008 the Federal Reserve pushed short-term interest rates near zero. We were certain this bond would get called. However, state and local governments were having a difficult time accessing the capital markets. Municipal bond insurers were under siege, having insured subprime mortgages without adequate capital or understanding of what they had insured. Banks and brokerage firms were now zombies, carrying impaired balance sheets with loans and securities that should never have been underwritten. These firms were unable to underwrite deals without offering extremely high yields to investors given the uncertainty in the markets. It was financially unattractive to call the bond at that time.
Eventually, the Build America Bond (BAB) program brought some needed relief to the market, providing support to the municipal bond sector. Liquidity and issuance increased as the universe of buyers expanded. Last month, we received notice that the issuer was calling the bonds as of December 10th. The timing could not have been much better for the Cumberland clients that held this bond. In the course of the last six weeks long-term Treasury bond yields have risen by 50-90 basis points depending on the maturity. Spreads on Build America Bonds have widened relative to Treasuries as supply pressures intensified. This supply bulge is a result of the BABs program expiring on December 31st. Cumberland has been buying bonds with similar or longer maturities and comparable yields to the Atlanta bond. We bid farewell to a bond that performed as we had hoped and expected. You don’t always get that lucky in the bond market these days. Wishing all of our clients and readers a healthy, happy, and prosperous 2011.