Municipal Liens as Asset Class

Chidem Kurdas

Yield-seekers once again face the question of where to go as they move out of junk paper. Risk-escaping money recently flowed to Treasuries and high-quality corporate bonds, but the yields on those are pitiful—certainly not sufficient to pay for pension liabilities or endowment needs.

Municipal tax liens are among the options described by Philip Siller and Andrew Plevin, founding principals of BroadRiver Asset Management, a specialist in fixed income alternatives.

Their object is to identify bond-like assets with better return for risk, that are safe from uncertainties posed by collapsing oil prices or Federal Reserve policy. Mr. Siller says they look for high-quality credit, reliable cash flow and low volatility.

Defaulted property taxes may not sound like the obvious choice by such criteria. But given time, 96% to 97% of defaulting property taxpayers pay up, said Mr. Plevin.

Many municipalities auction off liens on tax defaults that have lasted over a year. This raises money for municipal operating expenses that range from school and police payrolls to road maintenance.

Lien buyers pay the tax and penalties, getting in return the right to collect the tax and penalties, plus interest that can be as high as 18% or more annually. Defaulted property owners may have six months to three years to settle. In effect the lien is like a short-term mortgage.

What makes lien investments a valuable option for institutions is the chance to earn yield for relatively low risk. Rob Vowler, former chief executive of the Hershey Trust, recalls how difficult it was to significantly improve the risk-return profile of the portfolio—he now sits on the BroadRiver board.

If an owner does not pay by the lien deadline, the property goes into tax foreclosure, which by law overrides any mortgage and makes the lien holder the owner of the mortgage-free property. Typically the value of the real estate is many times the tax and related payments, so the lien holder is well protected.

However, hedge funds active in this field do not necessarily want to own real estate—that’s something for local developers looking to get properties on the cheap.

What the funds are after is the interest-bearing lien certificate, a sort of financial instrument, though subject to state laws and county procedures rather than national regulation. Interest rates, conditions and rules vary. You have to go county by county to construct a diversified basket of liens with the desirable attributes.

This is extremely labor intensive, requiring analytical, legal and market expertise, said Mr. Siller. But it offers reliable returns with not much connection to financial markets.

He and Mr. Plevin also invest in various other credit alternatives. Before founding BroadRiver in 2009, they started and ran the life insurance settlement desk of Goldman Sachs. The first BroadRiver fund was devoted to investing in insurance claims—another low correlation type of asset with a predictable pattern of payoffs.

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