Jul 8, 2019
I see sales to customers posted by the MSRB all of time that makes me shake my head in concern. These are municipal bonds that have what is known as “Mandatory Sinking Funds” which are disclosed in a municipal bond’s Final Official Statement and on municipal (muni) search sites and data bases like Bloomberg.
It means that a maturity was sold as a “term” maturity but bonds will be called away according to a set schedule on earlier dates. So the Bond description on your confirmation looks like this: Bangor ME GO Pension Obligation Int Rate 6.45% Maturity 06/01/2026 dated 03/01/2002 First Coupon 06/01/2002 Book Entry Only Cpn Payment Semi Annual on Jun 1 and Dec 1 Moody Rating Aa-2 S&P AA- Subject to Make Whole Call General Obligation Bond Natl Public Finance Guaranty Sinking Fund 06/01/2014 @100 Sunj to Fed Tax. The confirmation goes on to report your price paid and the Yield to Maturity.
Did you get that part about the Sinking Fund 06/01/2014 @100? On this bond it means that starting on June 1, 2014 Bangor started calling bond at 100.00 and here’s the Mandatory Sinking Fund Schedule:
Date Amount To Be Called
06/01/2014 $1.025 mil
06/01/2015 $1.180 mil
06/01/2016 $1.345 mil
06/01/2017 $1.52 mil
06/01/2018 $1.665 mil
06/01/2019 $1.865 mil
06/01/2020 $2.085 mil
Etc. until maturity when $3.8 mil will mature. So out of $28.8 mil only $3.8 will live to mature, the rest will be called earlier than maturity.
On June 5, 2019 bonds were sold to retail customers at 115.90 producing a Yield To Maturity of 3.83% and that was reported on the Trade Confirmation. What wasn’t reported is that if those bonds are called on the next MSF date of 06/01/20 the yield will be a Negative 8.605% (-8.605%).
The Average Life of the bond is actually calculated at 11/02/2023 using all the possible Sinking Fund call dates and amounts. In this case the Yield To Average life that the investors will get is 2.55% on 11/02/2023 (of course the call dates are 0n a June 1 so even this calculation is misleading and not correct unless you have the same amount of bonds called on each of the MSF call dates. If this buyer gets bonds called away on 06/01/2021 the yield is a Negative 1.405% (-1.405%) and if they have bonds called on 06/01/2022 the yields will be just 1.03% but at least it’s positive, at last.
Here’s the point: you have to look under the hood. On ALL premium bond offerings you have to ask before buying, “What are the Call Features, and is there a Mandatory Sinking Fund?” “When is the next/first call going to happen?” “If any of the bonds that you’re asking me to buy are called what are the yields?” If you have a discretionary account, read the confirmations.
If you see “SINKING FUND” call your advisor and get the dates, amounts and yields at the price on the confirmation and don’t be afraid to say “No Thank You, that bond doesn’t meet my investment needs.” “I don’t play the Sinking Fund Average Life Game.”
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