Are California Muni Bond ETFs In Trouble?

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In just two weeks, three relatively major Californian cities have filed for Chapter 9 bankruptcy protection.  The latest of which was San Bernardino, a city of a couple hundred thousand people that was facing a deficit of about $46 million.

The reasons for this rash of bankruptcies in the Golden State could be due to several reasons. Some analysts blame the state’s ‘Proposition 13’ which limited property taxes and the rate at which these levies could increase on a yearly basis (see Is The Bear Market For Bond ETFs Finally Here?).

Still others look to the large costs of public unions and their benefits as the main reason for the terrible financial conditions in many cities in the state. These costs are arguably eating up a big chunk of budgets and with smaller revenues flowing into city coffers, many have been put into a precarious situation where bankruptcy appears to be the only solution (see more in the Zacks ETF Center).

This is especially true given the lack of more federal support, particularly after the American Recovery and Reinvestment Act of 2009 already tried to offer up funds to struggling municipalities. Clearly, this plan to give states and cities more cash only postponed the day of reckoning, as revenues have not come back to higher levels leaving many municipalities in the same situation they found themselves in before the stimulus hit.

As a result of this confluence of events—lack of federal support, state laws, and heavy influence of public unions—more Californian cities could face bankruptcy or tumultuous times in the months ahead. Given this, some investors may want to keep a close eye on any bond investments they have in the region (read Floating Rate Bond ETF Investing 101).

From an ETF perspective, there are currently three muni bond ETFs targeting the Golden State. While these extremely diversified products haven’t been too impacted by the events in a few of the state’s cities yet, they could see more trouble should this trend in a few cities turn into a widespread panic.

For investors concerned about this, we have highlighted the three California muni bond ETFs which could act as a good barometer for worries over the broad state’s financial market as it relates to local level fixed income markets:

iShares California Municipal Bond Fund (CMF)

This product tracks the S&P California AMT-Free Muni Bond Index, a broad benchmark that produces a fund with roughly 325 holdings in total. The fund also has a relatively low cost, with fees of just 25 basis points a year.

Bonds in this security are tilted towards relatively high quality issues while generally maturing, on average, in about 5.66 years. In terms of sectors, bond are in the various purpose sector (23.4%), while utility (22.6%), and transportation (11%) notes round out the top three (see Three Muni Bond ETFs to Weather the Coming Storm).

So far in 2012, CMF has risen by about 3.8% so far in 2012, not too shabby considering the concerns building in the market place. Currently, the yield on the product comes in at 2.06% for 30-Day SEC terms while the taxable equivalent rate comes in at 3.17%.

SPDR Barclays California Municipal Bond Fund (CXA)

This ETF tracks a broad benchmark of Californian municipal bonds that have outstanding par values of at least $7 million. All securities in the index must have an Aa3/AA- rating or higher in order to be included in the fund. Overall, this gives the fund just 92 holdings in total although costs are just 20 basis points a year.

In terms of exposure, the average maturity is relatively high—suggesting modest interest rate risk—coming in at 16.22 years. Top individual issues are dominated by bonds from Los Angeles as three separate issues from America’s second most populous city are in the top three holdings of the fund (read Looking For Income? Try High Yield Muni ETFs).

Since the beginning of the year, CXA has done relatively well, adding 4.8% including a 2.5% gain in the past quarter. From a yield perspective, the product is relatively solid, coming in at 2.5% in 30 Day SEC terms, while the tax equivalent payout is roughly 3.85%.

PowerShares Insured California Municipal Bond Fund (PWZ)

PowerShares’ entrant in the space tracks the BofA Merrill Lynch California Insured Long-Term Core Plus Municipal Securities Index. This extremely long benchmark name basically means that the security will track a list of firms that are issued by California (or Puerto Rico for some reason) that are U.S. dollar denominated, investment grade, insured, and exempt from taxes.

With this focus, all of the 51 bonds in the fund mature in at least 15 years with 40% maturing in no less than 20 years from now. Puerto Rican bonds take the top spot at 6.1% of the fund, while San Francisco’s BART system and the West Contra Costa school district take up the rest of the top three from an individual issue perspective (see The Forgotten Municipal Bond ETFs).

Since the start of January this year, PWZ has gained about 4.2% with most of the gain coming in the first part of the time period.  The 30 Day SEC payout on the fund comes in at about 3.2% while the tax equivalent yield on the fund is a robust 4.92%.

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Read the analyst report on CMF

Read the analyst report on CXA

Read the analyst report on PWZ

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