Bond Blues

Recent interest rates on 10-year municipal bonds, combined with their built-in tax advantages, make for a very attractive investment. But underneath the averages were some disturbing default statistics, say bond gurus.

A few months ago, the interest yield on the average 10-year municipal bond was a bit higher than the yield on a 10-year Treasury note. Add in their built-in tax advantages and munis were looking like a very attractive home for an investor’s money. But underneath the averages were some disturbing default statistics, say bond gurus, which could be red flags for the average bond investor.

Last year, 183 bond issues, with a total value of $6.3 billion, defaulted, more than in any year since 1992, and bond analysts aren’t looking for any improvement over the next few years. The culprit, in many cases, is the collapsing real estate market. Of the bond issues that went belly-up, more than half were issued by Florida community development districts to help pay for infrastructure in development projects that ran aground when home values tumbled. Bonds like these are known as revenue bonds, since they depend on income from the entity that’s being financed, whether it’s a hospital, a toll road, or a real estate development, to pay principal and interest. When revenue bonds go into default, bond holders can expect to get back an average of 66¢ on the dollar.

If the security of your cash is an issue for you, general obligation bonds are a better choice, say bond traders. GO bonds, as they are known, are backed by the taxing power of the state, county, or municipality that issues them. Since governments rarely go out of business, you stand an excellent chance of getting all your money back in case of default. Investors who owned bonds issued by New York City and Orange County, California, for example, both of which went into default, got paid back in full.