Muni Bonds Boast Attractive Yields - Barron's

The credit market woes have benefitted buyers of municipal bonds. With long-term tax-free yields that can top 6%, Barron's Andrew Bary says munis have almost never been so attractive relative to U.S. Treasurys.

The market has been hurt by a wave of redemptions and a scarcity of buyers. There are also concerns that a weakening economy will lead to budget deficits for state and local governments, damaging the credit quality of municipal debt. Historically, however, muni bonds have had a better credit performance than corporate debt, and overall muni default rates remained very low even during the Great Depression.

The yields can be staggering too. Last week, 30-year bonds backed by the triple-A-rated Texas Permanent School Fund sold at a yield of 6.25%. Double-A-rated New York City issued bonds yielding up to 6.40%. Top-grade 10-year debt can yield 5% or more. A 6% muni yield is equivalent to a 10% taxable yield for residents of high income-tax states like California, New Jersey and New York, assuming residents buy in-state bonds, with 9% tax-equivalent yields for out-of-state bonds.

Long-term munis have historically yielded less than U.S. Treasurys because of the tax benefits, but the 5.9% yield on 30-year, AAA-rated munis is now around 135% of the 4.3% yield on the 30-year Treasury, the highest ratio in the past 20 years. Demand for long-term issues is weak, but short-term options abound. California just sold eight-month notes at an attractive 4.25% yield, especially when compared to the 1% rate on Treasury bills.

Investors have plenty of options for playing the muni market, including individual bonds, open-end mutual funds (VWITX, SNDPX, SMMOX), closed-end funds and muni ETFs (MUB). Closed-end muni funds reached record discounts of 30% or more this month relative to their net asset values, way above the typical 10-15%, but there's a risk that some closed-end funds will reduce leverage and thereby diminish yields.

The hardest hit big muni fund this year is Oppenheimer Rochester National Municipals (ORNAX), down 37% as of Thursday. Prices of bonds in the Rochester portfolio have fallen sharply on investor preferences for munis rated AA or above, and Rochester has been forced to sell bonds at a disadvantage. Even so, the credit quality of Rochester and the larger Rochester Fund Municipals (RMUNX) remains strong with minimal defaults, and the main short-term risk is that the funds will need to sell additional bonds to cover redemptions.

Investor preferences for highly rated munis are reflected in the near-record 2% yield gap between triple-A and triple-B munis. Amongst high-grade bonds, there is a further investor preference for general-obligation bonds and revenue bonds from well-regarded issuers, including the L.A. Department of Water and Power and the Port Authority of New York and New Jersey.

Comments

[Serge Birbrair:]

I like munies ETFs at those levels.
With Obama's Presidency as a large possibility, tax increases will support the demand for the tax free bonds.

2008 Oct 19 08:18 AM

[carey_jim:]

Who is rating and insuring municipal bonds these days?

For that matter, who is rating and insuring California, not to mention the Federal Government?

A healthy deflation would kill any state with a massive load of high yielding tax free bonds.

Care to pay $10 to cross the Golden Gate Bridge?

2008 Oct 19 01:08 PM

[Distressed ...:]

The Municipal Meltdown, the current health of U.S municipalities. I provide recent videos of Arizona, Florida, Mass, California treasurers on Bloomberg. Is there more pain ahead though????

www.distressedvolatili...

2008 Oct 19 02:35 PM

[unimpressed...:]

Munis are no safer than a strong stock. The fiscal condition of most states coupled with the state of the economy and the prospect of an Obama presidency and a Democrat Congress make an investment in their bonds a very risky venture. AAA means, absolutely, nothing in today's hazardous word of investment.

Personally, I advocate either cashing out of all investments and holding cash or sticking with the tried and true companies and mutual funds and riding out the uncertainty. Even an Obama administration is limited in what it can achieve and the length of time it can survive. The market, always, comes back and the American people will not tolerate a socialist agenda for very long.

However, Democrat dominated state governments (CA for example) have, already, done irreparable damage to the financial health of their state. Buying their paper, at any interest level, is a crap-shoot, at best, and a stupid blunder at worst.

2008 Oct 19 03:06 PM