My first municipal reset bonds

I wrote about using municipal reset bonds (“resets”) as a cash management vehicle in a recent post. Yesterday, I had my first success in a municipal resets auction. I submitted bids for resets with the following characteristics:

  • Issuers in different areas of the economy.
  • Issuers backed by different insurers.
  • No federal, state, local taxes. No AMT.
  • 7-day resets.
  • AAA-rated by both S&P and Moody’s. Additionally, they passed Fidelity’s “Risk Test” and are ated as “Tier 1″.
  • Have both “sinking fund” and “call” protection.

The bids were successful, and returned with an average coupon yield of about 3.8%, paid every week. This computes to an APY of (1+0.038/52)^52 – 1 = 3.872%.

For comparison, the table below shows the yields of various cash management vehicles as of September 5, 2007:

2007-09-06_muniresets.png

Clearly, the municipal reset bonds give me a 15 basis points increase in after-tax yield over the next competing product (Fido’s CA AMT-free MMF). The advantage over Vanguard’s CA Tax-Exempt MMF is around 26 basis points.

PS. The numbers are specific to my particular tax circumstances, which includes AMT; your numbers would differ.

Random list of previous posts:

    Stumble it!

    9 Responses to “My first municipal reset bonds”

    1. The Finance Buff Says:

      “The bids were successful, returned with an average coupon yield of about 3.8%, paid every week.”

      Should it be 3.8% for the first week and unknown for next week and the weeks thereafter?

    2. indexfundfan Says:

      You’re right. I wasn’t been clear.

      Like MMFs, the yields vary. For MMFs, the yields change every business day. For 7-day municipal resets, the yields are changed every 7 days.

    3. The Finance Buff Says:

      What I was trying to get at was that the bids themselves are not that important because they are only good for the first week. Even if you came back with 3.6%, lower than the MMF yield, you average yield may go up the next week, and vice versa. You are hoping over time your average yield will be 15-20 bps higher than that of a MMF. Are there issuers whose resets consistently yield higher than others or do they not matter? Any difference between hospitals, transit systems, cities, etc.? I’m not in these resets yet. I think I only have enough money for one reset from one issuer. Not sure if extra $50 a year is worth it.

    4. indexfundfan Says:

      tfb,

      Like all MMFs, the yields of resets will fluctuate from time to time. So this is nothing new. I already stated the reasons (in my opinion) in the earlier post why I expect resets to yield more on average than MMFs. So far this has been the case; and if this turns out to be false some time in future, there is no cost to get out since there are no CG or commissions involved.

      There are more knowledgeable people on resets/ARS at FWF. You might also get more opinions there.

    5. indexfundfan @ indextown » Blog Archive » The Trouble with Bond Insurers Says:

      [...] I wrote in my muni resets posts, I can easily get out of the resets in a matter of less than a week (I owned 7-day resets) if I had [...]

    6. Doug Says:

      I’ve owned bonds of this sort for many years. I’ve not heard the term “resets” used for them, they are technically “Auction-Rate Securities” (ARSs) because of the way that a dutch auction is used to reset the interest rate periodically (often, every 7 days).

      One risk of this type of security is the risk of a failed auction, that is, that an auction fails to find a market-clearing interest rate due to lack of buyers. When this happens, the interest rate is reset to some amount specified in the original issue, which is likely reasonably high. While that might be nice to receive, it could mean that you’d be trapped in the ARS until buyers could be found, in other words, you could lose liquidity.

      In light of the specter of ratings downgrades or outright failure of some of the bond insurers, I’ve become concerned about the effect that a loss of AAA rating might have on the liquidity of these investments. So when you say you can “easily get out of the resets in a matter of less than a week”, hmmm.

    7. Dave Says:

      Why not simply purchase a short-term MUNI fund? The Vanguard Limited-Term Muni yields 3.62%, has a duration of 2.7 years and an average quality of AA+. There is minimum NAV fluctuation. What do you see as the advantage?

    8. indexfundfan Says:

      Comments for Doug and Dave:

      I don’t believe failed auctions have happened before. I think the issuers would buy up the issues rather than have a failed auction. In any case, I agree that this is not a guarantee and there is still a risk.

      While the muni fund has minimum NAV fluctuation, muni ARS has NO price fluctuation. After deducting for state taxes, both are yielding the about same right now. However, muni ARS might have some additional risks in view of the possible insurer downgrades.

      I intend to revisit this whole issue soon.

    9. indexfundfan @ indextown » Blog Archive » Liquidated half of my municipal reset bonds Says:

      [...] I placed a call to the Fidelity Fixed Income Desk and submitted a request to liquidate half of my municipal reset bonds. The rep was very friendly and helpful. I read out the CUSIP numbers to him, he repeated them back [...]