MUB - HYMB: It's Not The Time For Junk Munis

2023-06-22 11:54:08 ET

Summary

• The SPDR Nuveen Bloomberg High Yield Municipal Bond ETF offers a high tax-equivalent yield of 7.9% but takes on significant risk by investing in junk and non-rated municipal bonds.
• Economic turmoil and a potential recession could lead to increased defaults in the high-risk municipal bond market, making the slightly higher yield not worth the risk.
• I rate HYMB a Sell.

The SPDR Nuveen Bloomberg High Yield Municipal Bond ETF (HYMB) offers exposure to high-yield municipal (muni) bonds. This ETF tracks the Bloomberg Municipal Yield Index . With AUM of about $1.9B, HYMB has a 30-day SEC yield of 4.7% and a tax-equivalent yield of about 7.9%. HYMB achieves this high yield by investing in riskier munis. While HYMB has a high yield, I don't think the risks are worth it. As we head into a recession, less risky options are a better alternative. I rate HYMB a Sell.

Holdings

HYMB holds 1727 munis, consisting of tax-exempt investment grade muni bonds, non-investment grade muni bonds (junk bonds), and non-rated muni bonds. HYMB's top 10 holdings make up only about 10% of its holdings.

What makes HYMB unique is that while it holds some investment-grade munis, it also holds a lot of junk munis and even not rated munis. If fact, the highest holding type, at nearly 43%, is not rated.

Only about 31% of HYMB's holdings are investment-grade . The other 69% are either junk munis or are not rated at all. According to the FDIC , "Municipalities are less likely to get bonds rated if they have characteristics that indicate higher risk. For example, issuers with lower local incomes and higher liability-to-asset ratios are less likely to get a bond rated." This obviously adds risk to the ETF in return for a higher yield.

This ETF holds mostly longer-term bonds. About 80% of its holdings are bonds that mature in 5 years or more. Its largest holding is in bonds maturing in 30 or more years.

This longer maturity time also adds to the overall risk of this ETF, again causing it to have a higher yield than a shorter-term muni ETF.

HYMB holdings are relatively diversified by state, with a slight over-concentration in Puerto Rico and California.

Yield

HYMB currently has a 30-day SEC yield of 4.7%. However, because munis are federally tax-exempt, looking at the tax-equivalent yield gives us a number to compare this ETF to other ETFs that aren't tax-exempt. HYMB has a tax-equivalent yield of about 7.9%. This is an impressive yield, but I don't think it is worth the risk.

iShares National Muni Bond ETF ( MUB ) is a muni ETF that holds high-quality investment-grade bonds, making it almost a mirror image of HYMB. Their tax-equivalent yields are shown below.

HYMB has a slightly under 2% higher yield than MUB because HYMB takes on much more risk. The question is whether or not this higher yield is worth the risk.

Is the risk worth it?

There are many signs that economic turmoil is on the horizon, primarily due to the interest rate hikes of the past 15 months. The impact of high rates and a slowing economy can already be seen in the muni bond market. In January 2023 , first-time payment defaults jumped 122% year-over-year. In 2023, Bank of America estimates about $1.7 billion to $2.1 billion worth of munis will default. In 2022, only $1.33 billion worth of muni bonds defaulted. Because the munis HYMB holds are high-risk, low-credit rating bonds, many of the defaults will likely come from these bonds.

In my opinion, considering all the turmoil that the high-risk muni bond market is going to face in the near future, I don't think now is the time to take a chance on risky munis with low or no credit ratings in return for only 2% more in tax-equivalent yield. I think that the spread between junk munis and investment-grade munis is far too small.

Why is the spread so small?

I believe that this spread isn't worth the risk because a recession isn't being factored in. For example, Goldman Sachs forecasts only a 25% chance of a recession in the next 12 months. The OECD is also forecasting a 0.9% GDP growth in 2024, well above what it would be if we enter a recession. SPY is up about 16% in the past year. Many investors are not pricing in a recession.

Although many forecasts say a recession isn't likely, there are some that agree with me and forecast one. The New York Fed model predicts a 71% chance of a recession in the next 12 months.

The information we have been given by the Fed on the future of interest rates also adds to my belief of a coming recession. Inflation has shown some signs of slowing down, and some investors even thought rate hikes were done. Now that we have been told to expect two more rate hikes in 2023, it shows that the Fed isn't taking any chances and is determined to lower inflation. This will likely push us into recession. A recession will cause an increase in the default rate of munis in general but could wreak havoc on the junk muni market.

A note for all munis

I feel like I should briefly mention that if you choose to buy this or any muni bond because of the yield, be careful looking at the tax-equivalent rate. The rates shown assume the highest federal and state income tax. So depending on the tax bracket you are in as well as your state, your personal tax-equivalent yield may be lower. There are many online tools that can calculate the tax-equivalent rate in your personal circumstance.

Conclusion

HYMB offers exposure to high-yield munis. HYMB takes on more risk than investment-grade muni ETFs by investing most of their AUM in junk or not rated munis. This ETF currently has a tax-equivalent yield of 7.93%. While this yield is impressive, I don't think it justifies the risk, especially considering the coming recession. I rate HYMB a Sell.

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