With today’s relatively low-yielding bond market and fears of inflation, many people are trying to “reach for yield” in pursuit of a passive income stream. One of the tamer options for this objective is high yield municipal bonds. A municipal bond is, at its core, a bond issued by a city, state, or local government, that can be backed by anything from its total revenue (called “general obligation” bonds) to the revenue generated by a sewer system or prison. The lowest-yielding municipal bonds will be general obligation, with the highest-yielding being backed by specific projects or revenue streams.
Municipal bonds are considered to be, as a group, safer than corporate bonds, but that does not mean that they are entirely risk-free. One particularly famous default is that of the Washington Public Power Supply System. They defaulted on over $2 billion of bonds in 1983, making it the largest municipal bond default in history and leading some to call it the “Whoops!” for its acronym, WPPSS. Luckily, municipal bond defaults are typically few and far between with only 0.07% of Moody’s “Investment Grade” and 4.29% of “Non-Investment Grade” municipal bonds historically defaulting on average, compared to 2.09% and 31.37% respectively with corporate bonds, a difference of default up to thirty times.
Municipal bonds’ payouts are insured in case of default by so-called “monoline” insurers, making the credit rating of the bond the same as that of the insurer. During the subprime mortgage crisis, monoline insurers took heavy losses on their mortgage-backed securities and their credit ratings dropped, making municipal bonds higher-yielding with their lockstep drop in credit rating. For those who research and select municipal bonds that they have reason to believe will pay out, now is a great time to achieve a higher yield on the exact same bonds that were yielding less in the recent past.