Any down sides of investing in (and reinvesting in) 10yr or 20yr callable FHLB bonds (besides the risk of rates dropping)? Not asking about the investment quality of FHLB, but specifically interested in the dynamics of getting in and out and back in to another bond as they get called and any inefficiencies around that (such as loss of interest paid).
I’ve had callable bonds called early before. The big pain is that it then creates a gap in my bond ladder that I have to deal with. Depending on how close to maturity the call happens and how far interest rates have swung, it may or may not be feasible to buy a different bond to fill the gap.
On a potentially related note, in a taxable account, the early call may trigger an earlier than expected capital gain, as well as possibly an additional payment for the year it gets called, depending on if there’s a “make whole” provision to the call and how that provision works.
My experience has been that it definitely feels more like a first world type problem than one I really need to worry about all that much. If you’re relying specifically on bond interest for spending money or are managing your income really tightly to qualify for a subsidy or a favorable Roth IRA conversion tax rate, it may be a bigger deal.
Regards,
-Chuck
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Generally callable bonds are called when the issuer’s bond rating has improved enough or interest rates have dropped enough to make it less expensive for the issuer to incur the expense to issue new bonds and call the callable bonds. So you are pretty much locking yourself into reinvesting at a lower rate, or at a lower credit rating in order to get the same amount of income - which is usually why people choose to invest in bonds.
AJ
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Most bonds have call provisions. They are described in the prospectus. You know ahead when they can be called and under what terms. It’s a good idea to check call provisions before you buy.
It’s usually no big deal. The money shows up usually in your brokerage account. It’s usually a refund of principle. No tax impact (unless you bought at a discount).
Bonds can be called for less than you paid for them. Thats a good reason not to pay more than par for them.
Thanks for the feedback - the capital gain aspect is an example of the type of thing I was not aware of.
Agreed. I’ve read elsewhere that FHLB bonds are very frequently called early, so if it’s due to rates having dropped only slightly (relative to my tolerance level), then I may still be reinvesting at rates above my target yield. Of course can’t predict that, but trying to determine if it’s worth it.
Good to know about them potentially being called for less than what you might have paid as a premium. I will keep that in mind. Thanks.
Well, it’s a good reason to always calculate YTW (Yield To Worst). You determine what the first call date is and then calculate the effective yield if it is indeed called. If that effective rate is still attractive to you, you might still choose to buy (even if the price is slightly above par due to rates having changed between issue and current).
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