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Make 20% a year off the government’s incompetence
by Charles Wolpoff
Increase your wealth by taking advantage of the incompetence of bureaucrats — with investments in distressed municipal bonds.
For starters, these offer tax-exempt high yields. If you’re in the 28% tax bracket, an 8% yield translates to an 11%-plus return.
Buy them at the right time and you can also lock in capital gains, for an overall return of 25% or more.
Heck in a handcart
Normally, municipal mismanagement is an ugly thing to behold. School roofs fall in, trash builds up in the alleys, and nursing homes “misplace” residents.
But all the while, you’re making money.
High-yield municipal bonds give you an opportunity to buy 8% tax-exempt bonds at a price low enough to give you 20% yields — tax free. (That’s federal tax free if you don’t live in the state in which the bond was issued, and federal, state and local tax free if you do).
And a 20% tax-free yield translates into a 28% taxable yield for those in the 28% tax bracket.
But that’s not the only advantage
Because you catch these bonds at the right time, you can buy them for a song. Seventy cents, sixty cents, forty cents on the dollar.
If you buy at forty cents on the dollar, and sell at sixty cents on the dollar, that’s a 50% capital gain, on top of the 28% taxable equivalent yield.
Take, for example, the first mortgage bonds issued by Escambia County for the Perdido Housing Corp. project in Pensacola, FL.
This bond paid for low and middle class housing projects at a time when there was already too much development. Typical bureaucratic boondoggle. It didn’t help that the nearby naval base was undergoing serious cutbacks.
So they’ve had to deal with 15 to 17 percent vacancy rates.
Although the bond has not yet missed an interest payment, it has been using up its debt reserve. This means the project may declare bankruptcy within a year or so.
Does that mean you should stay away from the bond?
Actually, it may mean exactly the opposite. You see, the managers of the complex already offered to buy the bonds from the bondholders at 70 cents on the dollar.
The bondholders declined.
Currently, you can buy it at less than 40 cents on the dollar.
That’s a cut-rate deal. Even if it lands in bankruptcy court, you will very likely get back at least 60 cents.
That’s a 50% gain!
The bonds, which mature in November of 2016, pay an 8% coupon rate. But at current prices, the yield is more than 12%.
Federal tax exempt, that is.
Which, again, means that if you’re in the 28% tax bracket, it’s equivalent to a yield on a taxable bond of close to 17%.
But if you do buy this bond, or one in a similar situation, be patient. You should be willing to hold it at least a year.
One factor that’s keeping the price of distressed municipal bonds low is the backwash from last year’s Heartland Funds debacle.
On October 13, the poor credit quality of its holdings forced Heartland to mark down the price of its two high-yield funds. Heartland High Yield Municipal Bond Fund was devalued by 69% and the Heartland Short Duration High Yield Fund by 44%.
The Securities and Exchange Commission swarmed all over them. Class action lawyers closed in.
And prices in the high yield muni market were pushed down. Of course, a weak economy has also kept a lid on distressed munis.
But with the economy turning around, this may be the right time to look into these investments.
For more information on the Perdido bond and other distressed muni bonds, you can call David J. Halliburton, the president of Halliburton & Associates, a broker in Clearwater, FL, that specializes in municipal bonds.
Play it right
If you want a way to get into the high yield muni area in a smaller way, while diversifying and reducing your risk, try a high yield muni fund with managers who have had long experience in this area, and examine carefully the quality of their holdings.
You don’t want to find yourself in the situation thrust upon Heartland Fund shareholders.
For example, take a look at the Scudder High Yield Tax Free Fund (SHYTX). While the S&P 500 has lost 23% in the last year, this fund has provided a return of 8.8%. A good portion of that will be exempt from federal taxes, and a smaller portion possibly from state and local taxes too, depending on the fund’s holdings and the state in which you live. For more, visit the Scudder website at investments.scudder.com, or call them at 800-728-3337.
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