Getting paid for municipal risk
Another great chart popped up on Twitter today that shows the historical performance of the two primary types of municipal bonds: general obligation (GO) and revenue. The Bloomberg chart maps the difference in yield between these two categories, which have different legal rights to public revenues. Generally, revenue bonds pay more interest than GO bonds because they only have access to the revenue of the project that issues them. GO bonds (the white line in the Bloomberg chart) are currently trading at an average of 4.12 percent annual interest; revenue bonds (the orange line) are trading at an average of 5.09 percent at present.
Revenue bonds have been getting a lot of attention lately. Defaulted revenue bonds that were issued for the Harrisburg incinerator project and Jefferson County sewer project have been making headlines for the rampant fraud and mismanagement that have plagued these municipalities. Despite these outliers, most revenue bonds are sound, although beware of the category of “dirt bonds” — municipal bonds issued to build out the necessary roads, sewers and other infrastructure for housing developments. As you might imagine, a lot of dirt bonds were issued before the housing bust, and the housing projects that were meant to repay them were never built.
Revenue bonds are much more heavily traded, too. Trade data from the Municipal Securities Rulemaking Board shows that the daily number of revenue-bond trades in the third quarter of 2011 was 24,379, versus 12,585 trades a day for GO bonds. Revenue-bond trades tend to be concentrated among smaller trade sizes, too. (Note: Municipal bond trade data counts each side of a trade done by interdealer brokers, too.)