Someone at work gave me an article from the Wall Street Journal titled “When Muni Bonds go Private” by Jeannette Neumann and I was immediately intrigued. Call me ignorant but the title of the article just didn’t make sense…how could a municipal bond be private? But the article provides the answer and to put it mildly it is just ridiculous. I should put it right out there, Conduit Municipal Bonds are not new. According to the same article they represent about 30% of the municipal bond market and over a third of those munis that have defaulted.
What is a Conduit Municipal Bond?
Investopedia provides a clear definition
An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects where the funds generated are used by a third party (known as the “conduit borrower”) to make payments to investors. The conduit financing is typically backed by either the conduit borrower’s credit or funds pledged toward the project by outside investors. If a project fails and the security goes into default, it falls to the conduit borrower’s financial obligation, not the conduit issuer.
Investopedia explains Conduit Issuer
Common types of conduit financing include industrial development revenue bonds (IDRBs), private activity bonds and housing revenue bonds (both for single-family and multifamily projects). Most conduit-issued securities are for projects to benefit the public at large (i.e. airports, docks, sewage facilities) or specific population segments (i.e. students, low-income home buyers, veterans
Hold up, so a local government is going to raise money for a project which is actually being completed by a third party and this third party is not being hired, per se, by the government but rather just getting a blank check? And to boot the federal government isn’t collecting taxes because it is a muni-bond?
The Wall Street Journal highlighted just one example,
When Million Air Interlink Inc. needed funds to refurbish three airplane terminals for private jets of affluent customers, the Houston company says, it was turned down by several local banks.
So it looked to two tiny Florida Panhandle towns that have no airports, Century and Gulf Breeze, for funding. They agreed this month to issue up to $76 million of tax-exempt municipal bonds on behalf of the closely held aviation company, whose terminals can include “elegant restrooms,” a BMW courtesy car for the crew and full-screen plasma TV monitors, its website says.
I don’t know many people who invest directly in the muni-bond market, but I would still be wondering how much of my bond fund is in this market?
Were you familiar with this type of arrangement?