Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

Corporate-Backed Municipal Bonds

Corporate-backed municipal bonds provide an excellent way to generate higher yield with uncorrelated credit risk to the rest of a tax-exempt portfolio. This is because corporate credit trends do not necessarily have to move in tandem with municipals, and this has been proven recently as we have emerged from the 2008 credit crisis. Going forward, as we enter a period of federal budget austerity, there are many high yield municipal sectors that will suffer because of their reliance on federal transfer payments. Examples include local indigent health care facilities and nursing homes. However, during the same time period, an investor can purchase a corporate-backed tax-exempt bond backed by, for example, a regulated electric utility, which may exhibit a much lower level of credit volatility, assuming it operates in a favorable regulatory jurisdiction.

Municipal bonds secured by a corporate entity have been around for a long time. Issuance was more common prior to the enactment of the Tax Reform Act of 1986, which closed loopholes in the tax code and cut out many abuses of the privileges of tax-exempt financing. The most common sectors include investor-owned utilities, airlines, and basic industry companies like paper or chemical producers.

More recently new issuance has been enabled by special legislation such as the Liberty Bonds Financing Program created after the tragic events of September 11, 2001, or the Economic Development Zone Act following ...