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The City of Detroit filed for Chapter 9 bankruptcy protection on Thursday, July 18, making it the largest municipality to do so in U.S. history. The city has liabilities of $18 billion, including $530 million in general obligation [GO] bonds.
Lord Abbett municipal bond funds do not own any of Detroit’s GO bonds. Lord Abbett Funds do, however, own revenue bonds backed by the city’s water and sewer systems. These bonds have not been included on the list of bonds with unsecured claims.
Both the water and sewer bonds, however, have been mentioned in the city’s financing plans and were recently downgraded to below investment grade, though they remain higher rated than the GO bonds. There also is some possibility that these revenue bonds could be restructured.
The decision by the City of Detroit to classify its GO bonds with other unsecured obligations, such as pension liabilities, could mean that holders of these bonds will lose most of their investment.
Traditionally, investors have considered these bonds to be secure because they are backed by the full faith and credit of the municipality. This has been interpreted as a promise to raise taxes, or do whatever is necessary, to make payments.
Michigan’s decision to approve the unusual path that Detroit has taken could mean that other bond issuers in the state may take a similar path in the future if they face similar distress. As a result, many municipalities in the state, and the state itself, could see increases in their future borrowing costs.
In the months to come, many questions will need to be resolved by the Michigan and federal courts, and these cases will receive much attention in the press. We will continue to monitor the situation and will provide updates when merited.
Risks to Consider:
The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. In addition, bonds may be subject to other types of risk such as call, credit, liquidity, and general market risks. A portion of the income derived from municipal bonds may be subject to the alternative minimum tax. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. High-yield securities, sometimes called “junk bonds” carry increased risks of price volatility, illiquid, and the possibility of default in the timely payment of interest and principal.
A General Obligation Bond is a municipal bond backed by the credit and "taxing power" of the issuing jurisdiction rather than the revenue from a given project.
A Revenue Bond is a municipal bond supported by the revenue from a specific project, such as a toll bridge, highway or local stadium. Revenue bonds are municipal bonds that finance income-producing projects and are secured by a specified revenue source.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.
Shares of Lord Abbett mutual funds are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including the possible loss of the principal amount invested.
Copyright © 2013 by Lord, Abbett & Co. LLC/Lord Abbett Distributor LLC. All rights reserved.