How to assess if MA muni bond will be called early

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

How to assess if MA muni bond will be called early

Post by JazzTime »

I am looking to purchase MA muni bonds listed on Fidelity's secondary market. (Note, I've bought a few new issue munis, but the yields on munis in the secondary market appear to be better.) My question relates to assessing the likelihood that a muni will be called early. Many of the MA munis that fit my search criteria have maturity dates in the mid 2030's. But many of them have call dates in the mid to late 2020's. There wouldn't be much point in buying a muni that will be called in two or three years. Therefore, I'd like to know if there is any way to assess the probability of an early call.

There is no need to discuss the option of buying a MA muni bond fund like FDMMX or VMATX. I am well aware. These funds do offer the convenience of liquidity, but their yields are a bit lower than individual bonds I can select myself. Plus, with an individual bond I know it will pay the full principal on maturity.

For background, my taxable portfolio (as well as deferred investments) are probably around 90% equities. Given that I can probably get somewhere in the vicinity of 4% double tax free muni bonds, that spurred my interest in venturing into bond land.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
User avatar
retired@50
Posts: 13947
Joined: Tue Oct 01, 2019 2:36 pm
Location: Living in the U.S.A.

Re: How to assess if MA muni bond will be called early

Post by retired@50 »

JazzTime wrote: Tue Jul 02, 2024 11:01 am ... My question relates to assessing the likelihood that a muni will be called early.
I'd be contemplating a couple things with regard to an early call.

As I understand it, a call is often initiated when the issuer can refinance the debt at a lower rate, so if interest rates fall in the overall economy, then a call would probably be more likely. Guessing at future interest rates is tough, so good luck on this particular metric.

Also, the credit rating of the issuer could come into play. If a municipality gets downgraded, then the bond is all of a sudden a bit riskier, and the issuer may not be able to access the lowest rates in the future, which would mean a call might be less likely. Conversely, if they get upgraded, then a call would potentially be more likely as they might be able to borrow at a lower rate.

Apart from call features, I'd also pay attention to the funding source for the interest payments. General obligation bonds are usually considered "safer" than single sources of revenue like a bridge toll, or a water or school district.

Regards,
"All of us would be better investors if we just made fewer decisions." - Daniel Kahneman
alex_686
Posts: 13649
Joined: Mon Feb 09, 2015 1:39 pm

Re: How to assess if MA muni bond will be called early

Post by alex_686 »

retired@50 wrote: Tue Jul 02, 2024 12:18 pm As I understand it, a call is often initiated when the issuer can refinance the debt at a lower rate, so if interest rates fall in the overall economy, then a call would probably be more likely. Guessing at future interest rates is tough, so good luck on this particular metric.
To put a finer point on this, calculating the probability distribution for future rates is a well understood subject. The math is solid, the models are well calibrated. It is fairly easy to extract the volatility values from Treasury options. This should get you into the ballpark.

Calculating the value of the call option is more complex. That requires a Monte Carlo simulation.

Credit spreads are a different, more complex, subject.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

Re: How to assess if MA muni bond will be called early

Post by JazzTime »

retired@50 wrote: Tue Jul 02, 2024 12:18 pm
JazzTime wrote: Tue Jul 02, 2024 11:01 am ... My question relates to assessing the likelihood that a muni will be called early.
As I understand it, a call is often initiated when the issuer can refinance the debt at a lower rate, so if interest rates fall in the overall economy, then a call would probably be more likely. Guessing at future interest rates is tough, so good luck on this particular metric.
I get that. So presumably, if interest rates declined to 2% and they could issue 2% coupon bonds to replace 4% coupon bonds, that makes perfect sense. But the bonds I am looking at on the secondary market were issued back in the 2000-teens when interest rates were much lower than today, yet those bonds have 4-5% coupons. Presumably, if they issued new bonds, they would also bear 4-5% coupons. Granted, they could sell them for a premium, but the original bonds were probably also sold for a premium. Then, the issuer has to account for the cost of calling the old bonds and issuing the new bonds. Presumably, that cost is not insignificant.

That's my completely uneducated and uninformed take on it. That's why I'm hoping some bond experts can clarify the situation. I have to admit that although I have been an equity investor since the 80's, I find bonds a bit perplexing. Hence, I generally stay away from them. Plus, I am generally not convinced that owning a bond with a 4% static coupon, whose principal valuation is subject to interest rate risk, is a good investment compared to a dividend stock yielding 3%, where the dividend increases every year and the stock valuation also increases. That said, I am willing to dip my toe into munis that are double tax free.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
psteinx
Posts: 5902
Joined: Tue Mar 13, 2007 2:24 pm

Re: How to assess if MA muni bond will be called early

Post by psteinx »

I've bought a lot of individual munis over the years (mostly for my state of Missouri).

Guesstimating which will get called, when, is an imprecise science at best.

The first rule of thumb is that if the price is significantly above par (say 104 or higher), then there's a good chance it'll be called at first opportunity, since the YTM is lower than the coupon yield. The issuer could issue new bonds closer to the YTM and save on the coupon.

The reverse is true for bonds significantly below par (say, 96 or lower).

These aren't hard and fast rules, and of course, if overall interest rates make a *big* move up or down, the situation could change.

===

Second, many munis have mandatory sinking provisions, which are essentially early calls. You'll have to look at the munis in question to identify those.

===

Third, I think larger, more sophisticated issuers are more likely to "refinance" at first good opportunity. Some small issuer with a $5M issuance out there might be far less inclined to call and refinance than a larger entity with $200M or more outstanding.

===

Finally, I would encourage you to generally look at yield to worst (YTW), rather than YTC or YTM. If the YTW is attractive, then you're somewhat protected.
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

Re: How to assess if MA muni bond will be called early

Post by JazzTime »

psteinx wrote: Tue Jul 02, 2024 4:46 pm
Finally, I would encourage you to generally look at yield to worst (YTW), rather than YTC or YTM. If the YTW is attractive, then you're somewhat protected.
Isn't YTW the same as YTC? That was my assumption. And that's what I use to screen the bonds that fit my search criteria. I'm looking for YTW (YTC) that is close to 4%. I often submit a bid slightly below the ask price and sometimes that gets accepted. I look at the recent trades for that bond as a check to what I am willing to bid. If a customer sold those bonds for 99.5 and the ask is 100.5, I might bid 100, figuring that is enough profit for the dealer. However, it is a mystery to me what governs what the dealer will accept.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
psteinx
Posts: 5902
Joined: Tue Mar 13, 2007 2:24 pm

Re: How to assess if MA muni bond will be called early

Post by psteinx »

YTW is the lower of YTC and YTM. I'm not sure if YTW accounts for sinking provisions.

If a (callable) bond is trading below par, then typically YTC > YTM, and YTW = YTM.

If a (callable) bond is trading above par, then typically YTC < YTM, and YTW = YTC.

[edit - fixed]
Last edited by psteinx on Thu Jul 04, 2024 6:33 pm, edited 1 time in total.
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

Re: How to assess if MA muni bond will be called early

Post by JazzTime »

psteinx wrote: Tue Jul 02, 2024 7:28 pm YTW is the lower of YTC and YTM. I'm not sure if YTW accounts for sinking provisions.

If a (callable) bond is trading below par, then typically YTC > YTM, and YTW = YTC. Shouldn't this be YTM?

If a (callable) bond is trading above par, then typically YTC < YTM, and YTW = YTM. Shouldn't this be YTC?
See above.

In all the bonds I've looked at YTC (YTW) is always less than YTM. In any event, I would not buy a bond trading much below par because, as I understand it, I might have to pay ordinary income tax on the gain represented by the discount.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
psteinx
Posts: 5902
Joined: Tue Mar 13, 2007 2:24 pm

Re: How to assess if MA muni bond will be called early

Post by psteinx »

JazzTime wrote: Thu Jul 04, 2024 11:31 am
psteinx wrote: Tue Jul 02, 2024 7:28 pm YTW is the lower of YTC and YTM. I'm not sure if YTW accounts for sinking provisions.

If a (callable) bond is trading below par, then typically YTC > YTM, and YTW = YTC. Shouldn't this be YTM?

If a (callable) bond is trading above par, then typically YTC < YTM, and YTW = YTM. Shouldn't this be YTC?
See above.

In all the bonds I've looked at YTC (YTW) is always less than YTM. In any event, I would not buy a bond trading much below par because, as I understand it, I might have to pay ordinary income tax on the gain represented by the discount.
Yeah, sorry I got the YTW reversed (fixed now).

Yes, on the taxability. To a rough approximation, the difference between YTW and coupon rate is taxable. If you've got a bond with a 3.0% coupon, trading at 90, with a YTW of 4.0%, then about 1.0% of that 4.0% YTW will be taxable. Those taxes are normally paid when the bond matures/is called/sold, so there's generally some tax deferral there which softens the blow.

Because rates went way up about 2 years ago from where they had been for years, most bonds issued in 2021 or before have low-ish coupons, trade below par, and have YTW > Coupon, which means they're partly taxable. But as, per above, a 3% coupon bond with a YTW of 4.0% or 4.5% is still pretty favorable taxwise.
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

Re: How to assess if MA muni bond will be called early

Post by JazzTime »

Thanks psteinx.
Some of the bonds that show up on my search have 5% coupons with maturity in mid-2030 and call date of 2026 or so. They may be priced at 101-102 (roughly) so have YTC of 3.9 (roughly) and YTM of 4.5 (roughly). Obviously, I would prefer that they not be called early to get the higher yield. In addition, if they are called early, then I would be forced to reinvest sooner, perhaps at less favorable rates.

The other option would be choosing a 4% coupon bond, priced closer to 100. There the YTC and YTM are much closer, say 3.9-3.95, but perhaps that type of bond is less likely to be called early.

That's what I'm trying to sort out.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
bombcar
Posts: 2187
Joined: Sun Aug 12, 2007 6:41 pm

Re: How to assess if MA muni bond will be called early

Post by bombcar »

I suspect the yields are better by the exact current market's opinion on the chance they'll be called.
JayB
Posts: 708
Joined: Sat May 28, 2022 9:57 am

Re: How to assess if MA muni bond will be called early

Post by JayB »

JazzTime wrote: Fri Jul 05, 2024 1:42 pm Thanks psteinx.
Some of the bonds that show up on my search have 5% coupons with maturity in mid-2030 and call date of 2026 or so. They may be priced at 101-102 (roughly) so have YTC of 3.9 (roughly) and YTM of 4.5 (roughly). Obviously, I would prefer that they not be called early to get the higher yield. In addition, if they are called early, then I would be forced to reinvest sooner, perhaps at less favorable rates.

The other option would be choosing a 4% coupon bond, priced closer to 100. There the YTC and YTM are much closer, say 3.9-3.95, but perhaps that type of bond is less likely to be called early.

That's what I'm trying to sort out.
Once logged into Fidelity, if you click on a bond description, you can then look for "Workout Date" under Issuer Information. As Fidelity puts it, "based on the current price and call schedule for a bond, this is the date when the bond is most likely to be called or redeemed." This will at least give a current reading as to when the bond might be called. I take it that this is based on some proprietary number crunching.
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

Re: How to assess if MA muni bond will be called early

Post by JazzTime »

JayB wrote: Fri Jul 05, 2024 2:01 pm
Once logged into Fidelity, if you click on a bond description, you can then look for "Workout Date" under Issuer Information. As Fidelity puts it, "based on the current price and call schedule for a bond, this is the date when the bond is most likely to be called or redeemed." This will at least give a current reading as to when the bond might be called. I take it that this is based on some proprietary number crunching.
That's interesting. I'll take a look at that "workout date" info this week when I next pull up my search criteria.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
User avatar
Topic Author
JazzTime
Posts: 778
Joined: Mon Oct 25, 2021 8:43 am
Location: MA

Re: How to assess if MA muni bond will be called early

Post by JazzTime »

JayB wrote: Fri Jul 05, 2024 2:01 pm
Once logged into Fidelity, if you click on a bond description, you can then look for "Workout Date" under Issuer Information. As Fidelity puts it, "based on the current price and call schedule for a bond, this is the date when the bond is most likely to be called or redeemed." This will at least give a current reading as to when the bond might be called. I take it that this is based on some proprietary number crunching.
Ok. I looked at the "workout date" for several bonds, some I already own and some that showed up in my search criteria. I'm not sure that info is helpful. The listed "workout dates" were either the first call date or some nonsense date, like 01-01-0001.

So I'm still in a quandary about assessing the likelihood of an early call when purchasing a bond.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
JayB
Posts: 708
Joined: Sat May 28, 2022 9:57 am

Re: How to assess if MA muni bond will be called early

Post by JayB »

JazzTime wrote: Tue Jul 09, 2024 2:47 pm
JayB wrote: Fri Jul 05, 2024 2:01 pm
Once logged into Fidelity, if you click on a bond description, you can then look for "Workout Date" under Issuer Information. As Fidelity puts it, "based on the current price and call schedule for a bond, this is the date when the bond is most likely to be called or redeemed." This will at least give a current reading as to when the bond might be called. I take it that this is based on some proprietary number crunching.
Ok. I looked at the "workout date" for several bonds, some I already own and some that showed up in my search criteria. I'm not sure that info is helpful. The listed "workout dates" were either the first call date or some nonsense date, like 01-01-0001.

So I'm still in a quandary about assessing the likelihood of an early call when purchasing a bond.
The nonsense date is simply a placeholder when there is no workout date to project. If the workout date is the first call date, I would pay attention to that.
Post Reply