This is almost getting silly: Muni Bond Yields

In a normal world, muni bonds yield slightly less than taxable bonds, such as treasuries. If a 10-year treasury bond was yielding 2.6% (like it is right now), we would expect a muni bond to yield somewhere between 2% and maybe 3%. The low end would be for ultra-safe state general obligation (ie, "unlimited taxing authority") bonds and the higher end might be a lower-rated local government entity.

We bought some 11-year muni bonds this morning yielding 7.625%. That is not a typo. An after-tax yield that is about three times what we can earn on a treasury bond -- and over 4x if we consider taxes. You might wisely ask -- what's the catch? Surely this must be some kind of junk bond...? Nope -- I'd put my grandmother's life savings in this bond.

The muni bond world breaks down into three big buckets. The first bucket (that I put no money into) is bonds sold for private non-profit things like hospitals, universities and other charitable enterprises. We also include here such things as pollution control bonds and airport terminals. These are essentially corporate credits, and I don't invest in them.

The rest of the muni world is bonds sold to fund what we think of as essential public facilities: Roads, schools, libraries, water systems, etc. There are two types of these bonds: Those supported by a direct revenue stream and those supported by the "general fund" of the agency or city. If you've been reading the paper, you know that local and state agencies are under extreme financial stress right now. Elected officials will have to make the tough decisions about how to allocate a fixed revenue stream. There is risk in this process for bondholders -- if the agency's fixed obligations (pensions, public safety, basic teacher head-count, etc.) exceed its revenues, there is some risk for interest payments. That type of bond does, perhaps, deserve to sell at higher yields.

The other type of local government bond is not affected by these other demands. Some muni bonds are paid from property taxes or other revenues that do not first pass through the general operating fund of the agency. Those revenues are captured, sequestered and used to pay the bondholders. Property owner pays taxes; county captures taxes; taxes go to bank to pay our bonds. I like that arrangement. The Governator can't get his hands on my money!

That is the type of bond we've been buying. For technical reasons, bond mutual funds are being forced to dump bonds on the market -- bonds with a very high degree of security that in many cases were not rated by S&P or Moody's when the bonds were issued. The bond we bought today is secured by special property taxes on over 4,500 housing units in Irvine, CA. I have worked on projects like this as an investment banker, tax administrator and disclosure consultant for over 20 years. Getting paid 4x over treasury yields to take this little risk is as good an investment as I have ever seen.

To the point that it's almost silly. I keep pinching myself.