Investors chasing higher muni yields — all the way to Guam

You can find tax-exempt yields of 5 percent and more in the municipal bond market, if you are willing to confront risks such as typhoons, earthquakes, angry voters and a record of failure. If you seek 5 percent, Telluride, Colorado, wants to lease you its town hall. You can get 6 percent to help finance train service between downtown Denver and the city's airport. There are 7 percent yields for those willing to help pay for a new high school, on the island of Guam. And on the bonds used to build a continuing-care retirement community in Geneva, Illinois, 40 miles west of Chicago, you can get 8 percent. These aren't good old municipal bonds, the nest-egg investments that have a default rate of less than one-half of 1 percent. Those bonds yield just over the default rate these days, maybe 1 percent, 2 percent, 3 percent if you're lucky. Investors in the Jazz Age got more income from their bonds. What passes for high yield in municipals these days is accompanied by unconventional risk. How far do you have to go for a few extra basis points? Telluride, Colorado, population 2,348, is famous for its skiing and film festival, and in August it sold $9.8 million in certificates of participation, backed by lease payments on its town hall and other properties. Telluride leased them to Wells Fargo Bank, the certificates' trustee, and is leasing the properties back from the bank. Rated A1 by Moody's Investors Service, the yield on the COPs due in 2036 was 5.07 percent. No Obligation Telluride says it expects to make the lease payments from general revenue, including a sales and use tax and a real estate transfer tax. Mind you, the town isn't pledging those taxes to repayment of the COPs, according to the securities' offering document, known as an official statement. The town has other bonds with a prior claim on those taxes. And the COPs don't constitute “indebtedness.” The town isn't obligated to make any payments other than those “which may be appropriated” every year. This gossamer security may sound unusual to untrained ears, yet it is a common structure in the municipal market: bonds are backed by taxes or certain revenue streams; COPs are backed by nothing but promises. Far to Go This being Colorado, there are always initiatives on the ballot, and November of 2010 is no different. Proposition 101 reduces taxes and fees; Amendment 60 limits property taxes; Amendment 61 would “prohibit the State from issuing debt and entering into other types of borrowings or financings whatsoever.” It would also limit localities' ability to enter into such transactions, including deals like these certificates, according to the official statement's “Risk Factors” section. That's pretty far to go for 5 percent. Amendment 61 may figure into the Regional Transportation District's plans to expand rail service around Denver, a drive of more than six hours from Telluride. The RTD sold $398 million in bonds in August to help pay for a portion of the construction, which is being handled by one of those public-private partnerships you may have heard so much about, if you care about infrastructure. The district will want to sell more bonds at some point, which is where Amendment 61 may come in, if it's passed. A term bond of $175 million due in 2041 carried top yields of 6.13 percent. Moody's rates these Baa3, which is the bottom of the investment-grade scale. The official statement is 662 pages long. The “Risk Factors” section runs to a bit more than 16 pages. I love the idea of planning long term for commuter and light rail. If you want to get involved with these 6 percent bonds, you'd better, too. Guam High Guam, part of the Marianas Islands chain in the Pacific, is a territory of the U.S., which is why it gets to sell tax-exempt municipal bonds. Guam's Department of Education expects to close this month on $66 million in certificates of participation, which includes a $36.7 million maturity due in 2040, priced to yield 7 percent. The COPs will be used to finance a new high school, which Guam will then lease from a not-for-profit corporation, CaPFA Capital Corp. 2010A, “created to serve as an instrumentality of the City of Moore Haven, Florida,” as it says in the official statement. That's interesting, in the way that all munis are, especially ones rated B by Standard & Poor's, like these. Yes, that's a junk rating. ‘Super Typhoons, Earthquakes' The real bet here is on the Guam Legislature. Investors are betting that the lawmakers will appropriate the money to pay debt service. The legislature is under no obligation to do so. Among the other “investment considerations” listed in the official statement are “periodic typhoons, super typhoons and earthquakes.” Finally, consider the Illinois Finance Authority's unrated $117.6 million revenue bonds -- about one-quarter of the municipal market isn't rated, according to a 2004 Securities and Exchange Commission report. The issue included a $41.5 million maturity due in 2046, priced to yield 8.35 percent. The bonds are being used to build a retirement community that includes “147 independent living units, 51 assisted living units, 26 memory-support assisted living units and 43 nursing beds,” according to the official statement. Multiple Risks There are more than 23 pages of risk factors. Investors have to worry about getting the facility built and about maintaining a certain level of occupancy. They have to think about health-care reform and regulation, Medicare and Medicaid, and nursing shortages, among other things. And in return: 8.35 percent, tax-free. That is, free of federal taxes. The bonds aren't exempt from state taxes. And there's a par call in 2020. As I said, the default rate on municipals is less than one- half of 1 percent. But not all munis are alike. On non-hospital related health care, which includes continuing-care retirement communities, like this, the rate is 17 percent, according to a Fitch Ratings default study in 2003. It's not easy, but this is how to get 5 percent, 6 percent, 7 percent, 8 percent in munis. Or at least it was when these bonds were first priced. This being the municipal market, of course, the prices on almost all of these have been bid higher. Risk? What's that? (Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)