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Municipal bonds have long been a favorite of those who fall into high tax brackets, as the favorable treatment of dividend and principal payments can translate into an impressive taxable equivalent yield. These debt instruments are issued by state governments and local municipalities, and are generally supported by either the taxing power of the or the revenues expected to be derived from a particular project. Since state and local governments do not regularly default on their obligations, the risk associated with municipal bonds has historically been very low.

New York Muni ETFs Are Far From Risk FreeWhile skyrocketing unemployment rates and plummeting property values have weighed on household budgets across the country, these trends, along with diminished consumer spending, are also wreaking havoc on government balance sheets. Tax revenues have slumped while outflows are on the rise, sparking a wave of budget crises across the country. And while California has perhaps stood out as the state facing the most dramatic budget shortfalls, a steadily deteriorating fiscal situation in New York is now forcing investors to reevaluate the risk of debt issued by the Empire State and its various municipalities.

Rocky Road

For the first time in its history, New York’s main bank account is in the red, and the state has been forced to tap a short-term investment pool that also maintains a dangerously low balance. As legislators hold out hope that the arrival of Wall Street bonuses in January will pad the general fund, the state has begun delaying payments to the pension and school systems. Still, the budget deficit is expected to grow in 2010, possibly forcing governor David Paterson to implement layoffs and furloughs unless an impasse with state legislators is broken.

“The lower the short-term balance falls, the harder it is for the state to cover its day-to-day bills and the closer New York moves toward a previously unimaginable eventuality: A government check that bounces,” writes Nicholas Confessore. “And the financial problems will raise alarms among rating agencies that are already keeping a close eye on New York’s credit-worthiness, with the risk of a lower credit rating — and higher interest payments to future bondholders — already looming.”

New York Muni ETFs

While U.S.-listed municipal bond ETFs offer diversified exposure across a number of issuers (see a complete list here), there are a handful of funds that invest exclusively in bonds issued by New York municipalities. ETFdb Pro members can access profiles and ETF recommendations in the ETFdb Category Report ETFdb Pro Members Only (if you’re not a Pro member yet, sign up for a free trial or read more here).

  • iShares S&P New York AMT-Free Municipal Bond Fund (NYSEARCA:NYF): This ETF tracks an index that is designed to measure the performance of the investment grade segment of the New York municipal bond market, investing in bonds that are exempt from the AMT and have a rating of at least BBB- from S&P or Fitch or Baa3 from Moody’s. NYF has about 115 individual holdings, and maintains an S&P credit rating of AA-.

NYF

  • PowerShares Insured New York Municipal Bond Portfolio (NYSEARCA:PZT): This ETF is based on the BofA Merrill Lynch New York Insured Long-Term Core Plus Municipal Securities Index, a benchmark designed to measure the performance of AAA-rated, insured, tax-exempt, long-term debt issued by New York or Puerto Rico, or their political subdivisions. Reflecting the current environment, only about 60% of this fund’s holdings maintain a AAA rating from S&P. Almost 70% of PZT’s holdings have a time to maturity of at least 20 years.

PZT

  • SPDR Barclays Capital New York Municipal Bond ETF (NYSEARCA:INY): This ETF is linked to a benchmark comprised of publicly-traded New York municipal bonds that cover the U.S. dollar denominated tax exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. Currently, INY has an average coupon of 4.8% and an average credit rating of AA3.

INY

Disclosure: No positions at time of writing.

Source: Eye on New York Muni Bond ETFs