The Opportunity for Income Investors

It’s not just students who may be thinking about school this fall. Income investors have an opportunity to invest in bonds that help finance school projects — and can possibly earn a yield of around 6% after tax considerations are taken into account. Local municipal general obligation bonds help fund operations or specific projects. For school districts, that can mean money for things like renovations or new buildings. They are backed by full faith and credit of the issuer and, like all municipal bonds, interest is exempt from federal tax. In some cases, the bonds are free of state taxes as well.

Historically Attractive Yields

Right now, yields for local general obligation munis are historically attractive at about 3.7%, said Cooper Howard, fixed income strategist for the Schwab Center for Financial Research. For those in the highest tax bracket, that can mean yields can reach over 6% on a tax-adjusted basis, Howard said. Add in the waiver of state taxes from high-tax areas such as California and New York, and the yield could be even higher, he said.

Solid Credit Quality

In general, the credit quality of local general obligation munis is pretty solid, said Richard Schwam, a municipal credit research analyst at AllianceBernstein. “The vast majority of them are still in very good financial shape given all of the stimulus that they received back in 2020 and 2021,” he said. They also got added tax revenue as Americans received stimulus money and pumped it back into the economy, he added.

Stability and Potential for Improvement

While revenues related to income and sales tax may slow, property taxes remain stable. In fact, property values have risen significantly over the past several years, which could eventually translate into more revenue from property taxes, Howard pointed out. Those levies are based on the assessed value of the property, which means there is usually a lag before the assessed value catches up to the current market value. “It usually takes about three years for the market value to translate through to new higher revenues,” Howard said. Local general obligation bonds also tend to be very highly rated, Howard said. About 45% are AAA rated, versus 21% in the broad muni market, he noted. “You are getting something that is high credit quality to begin with and we think the credit backdrop is relatively stable right now and could possibly improve,” Howard said.

Considerations for Investors

When investing in local general obligation bonds, it’s important to do your homework on the area’s credit, including its reserves and balanced budgets. Look for areas that have a stable or rising population and higher income earners. Avoid smaller municipalities with a history of financial problems. Diversify your investments across multiple states, but be aware of potential state income tax implications. You can also consider investing through a mutual fund or exchange-traded fund that has a higher allocation to local general obligation munis than the broad index, which means more than 15%.

Investment Options

Schwab’s Municipal Bond ETF and Vanguard Tax-Exempt Bond ETF are examples of funds with a significant allocation to general obligation bonds. However, it’s important to be aware of fees that are charged and the fund’s track record.