Saturday, November 29, 2008

Thoughts on Muni Bonds

With respect to municipal securities, it is an "interesting" time. Unlike treasuries, muni's are not considered "risk free" and they have offered an after-tax yield (AT Yield) higher than available through treasuries. Compared to historical norms, the spread between the AT Yield and the yield on treasuries is high. Why? Many muni borrowers are faced with declining revenues (taxes and use fees) as the economy sours.

Before anyone invests in munis, they need to know there are two types of municipal bonds.

  1. General Obligation Bonds – backed by the full faith and credit of the borrower, they are considered "safer" than revenue bonds. Bottom line, the creditworthiness of the critical to valuing GO Bonds.
  2. Revenue Bonds – not backed by the full faith and credit, the "payback" of the bonds depends upon the revenue generated by the project backing the bonds. Common revenue bonds – infrastructure (sewers, toll roads, etc.) and special projects (stadiums). If the project fails to generate enough income to pay the interest and principal due on the bonds, the issuer is not legally responsible for making you whole.

Because I perceive the overall risk of munis as manageable, I have money invested in a tax free money market fund and think many of them offer a fair risk/reward at current pricing. Nevertheless, I would avoid a few issuers like the plague:

  1. New York State and New York City. As Wall Street prospered, employers paid enormous bonuses to employees of investment banks, hedge funds, and other financial professionals. Eventually, both the city and the state became dependant on income taxes on these bonuses and taxes on things purchased with bonus dollars (real estate, sales, etc.). With "bonus" tax revenues gone for the short term (and probably the long term), both the city and state face enormous annual budget holes.
  2. California: Enormous government spending and the implosion of the housing market is a bad combination.



1 comment:

Anonymous said...

Munis are truly a good deal right, but maybe only compared to the alternatives. Treasuries are paying zero to almost nothing, while tax-free munis are paying 5-6%. Of course, the reason is that government at every level is going broke, but the Feds can print money. If you are interested in munis, you can go to to find an advisor who specializes in them.