Where to Find 'AA' Municipal Bonds Yielding Over 5%

posted on 06-07-2019

Yields on 10-year Treasuries are now below 2%. And 30-year U.S. Treasury yields average less than 3%.

But I've found a group of government bonds yielding upwards of 5%.

Most of them carry high quality "AA" credit ratings. And since I first brought them to the attention of High-Yield Investing readers in June 2010, they've returned better than 20%.

They're called "Build America Bonds."

You may have heard of them. The program has proven to be one of the more successful outcomes of Obama's $800 billion stimulus package, the American Recovery and Reinvestment Act of 2009. The federal government designed the bonds to stimulate the economy by creating employment at the local level.

Like other municipal bonds, the debt is used to finance local construction projects, such as bridges and roadways. The new bridge across the San Francisco Bay and the mass transit system in New Jersey were financed with Build America Bonds.

As with other municipal bonds, interest payments are exempt from local taxes in the state of issue. Unlike most municipal bonds, however, interest on Build America Bonds may be subject to federal taxes, depending on which of the two types of bonds are issued.

Municipalities can offer a tax credit to the buyer and receive a 25% subsidy on interest payments from the U.S. Treasury. But the most popular issue is taxable and gives the municipalities a direct payment from the Treasury for 35% of the interest payments. Either way, the subsidy reduces borrowing costs while allowing municipalities to offer higher, more enticing yields than they could otherwise afford.

With up to 35% of the interest backed by the U.S. government, most Build America Bonds carry a "AA" credit rating. Many are general obligation bonds, which require municipalities to raise taxes if they can't make interest payments. Others are backed by revenue from essential services, including water and sewer projects.

These bonds weren't expected to deliver the kind of returns investors have seen since the program expired in December 2010.

#-ad_banner_2-# Instead, a cloud of uncertainty was expected to hang over the bonds and the funds that own them as the limited number of bonds available in the market could negatively affect their value.

In fact, the reverse has happened.

Precisely because no new Build America Bonds have been issued, investors have bid up prices.

It's not so easy to buy individual Build America Bonds since institutional investors have scooped them up. But there are a handful of Build America Bond funds, including three exchange-traded funds (ETFs) with the tickers (NYSE: BAB), (NYSE: BABS), or (NYSE: BABZ), yielding around 5%, and a couple of leveraged closed-end funds (CEFs) with the tickers (NYSE: BBN) and (NYSE: GBAB), which throw off yields of around 7%.

The Investing Answer: Keep in mind that if interest rates rise, these long-term bonds could come under pressure. Also, as the global economy strengthens, investors will likely rotate into higher-risk growth plays. For now, however, Build America Bonds offer some of the best yields around for safety-conscious investors.

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