Do Bonds Die?

While usually my posts have been silly and fun this one touches on a bit of a more serious topic. This week a close friend that I grew up with lost her Mother to brain cancer. The saddness and frustration I feel can't be put into words on how this insulting disease took a vibrant woman from our world. When thinking about how to cope with this, I realized the best way is to think about how Anita Friede is still with us. Her certain nuances, sense of humor, way with words and style savvyness live on in her daughters. Also the memories from people who's lives she touched keeps her with us. While the feelings an investor will feel when losing an investment cannot compare to losing a loved one, when a bond defaults it usually ends up sticking around in the same way that Anita will.

The default rate on municipal bonds is extremely low to begin with but if you look at the default rate on general obligation bonds that are rated minimum bank investment grade (Baa3/BBB-) the default rate is less than 1%. The only state general obligation bond that has defaulted in the past 100 years was the state of Arkansas during The Great Depression. Typically when a bond defaults, it will miss an interest payment or two and then will end up paying off in arrears meaning that the bond will pay it's interest late and will also pay interest on the lapsed time. Basically more often than not once a bond has "hit the D" it still lives on and pays off in full just a little late. This was the case with Arkansas in the 1930s.

A number of small towns default on bonds every year. Mainly these towns are unrated because the issue of bonds was so small they didn't want to pay for a rating. The reason some of them default is usually due to the fact that the town had an unexpected expense that it had to pay off first and then could continue paying it's interest.

The moral of the story is when a bond defaults, don't panick, it's likely that you will end up getting all of your principal and interest back just a little later than expected. I can only compare this to Anita because she left such a mark on the world that even though she has phyisically left us, those who knew her will benefit from their time with her in the years to come.