Some Muni Bonds Appear Screaming Buys Here

I try in my writings to be low hype, so I avoid brash headlines. Every now and then, though, one has to pound the table. With muni bonds today, there are some screaming bargains out there, even if you can’t benefit from the tax deduction. When have we ever seen muni yields at significant premiums to taxable Treasury yields? I can’t think of such a time in my investment lifetime.

Should life insurance companies, which can’t fully benefit from the tax deduction buy here? Yes. Banks? Yes. Pension plans? Yes. Endowments? Yes. Pretend that they are taxable securities for a moment, and buy them on a spread basis. When the need for tax avoidance reappears, you will be more than rewarded.

For institutional investors, hedge with Treasuries or Swaps if you are worried about the long end of the yield curve rising. Beyond that, I would simply say, stay diversified, and make sure that the munis that you buy have an unshakable economic purpose behind them.

Related: Muni Bond ETFs and CEFs

Comments

[dukeb:]

"When have we ever seen muni yields at significant premiums to taxable Treasury yields?"

So that begs the question of WHY we are seeing that now, no? Are they just feeling generous?

2008 Mar 02 08:11 AM

[Rajiv Sethia:]

Which ETFs or ETNs invest in AAA muni bonds? I know I can find out with a bit of research but if someone knows do put the ticker symbols in.

2008 Mar 02 10:33 AM

[farkus:]

I imagine the typical reader of seekingalpha has some idea of why muni's are spread positive to Treasuries, but it does beg the question of whether spreads can and will continue to widen. For an actual explanation of what is going on in the muni market, and why munis might be a good investment here, google Bill Gross's 2/29 interview on the Fox Business Channel.

2008 Mar 02 11:28 AM

[James Cullen:]

Dukeb,
There is this whole "muni bond insurer" issue...

2008 Mar 03 08:09 AM

[User 108022:]

There were 2 other periods when municipal rates were cheaper than US Treasuries. One was during the NYC crisis in the mid-1970's with the issuance of MAC bonds and the other was in the late 1980's brought on by a rash of municipal issuance before the Tax Act of 1986.

2008 Mar 03 09:56 AM

[David Barsan_:]

Obviously the "muni bond insurer" issue is at the forefront of the discrepancy, but I think you have the proverbial "baby getting chucked with bathwater" thing happening, and the "unshakable economic purpose" the author references looking for seems to be very sound advice.

If the price is down simply because it's questionable the insurance wouldn't cover in the event of a default, but the reason behind the bond issuance was valid/needed/funded it seems we have some very good deals out there.

2008 Mar 03 02:20 PM

[locke:]

Any opinions on which Muni ETF is safest?

Buying Munis in a Roth IRA would be a dumb move, right?

2008 Mar 03 02:23 PM

[Biomaven:]

One of the reasons for the high rates may be the failure to find new buyers of the Auction Rate Preferreds that many closed-end muni bond funds use for leverage. The Common holders of these funds are protected by a maximum interest rate set if the auctions failed - so typically costs for these funds will rise only a little. But the failures are embarrassing for the sponsors of these funds, and so they will perhaps be tempted to deleverage the funds some (and so sell munis).

I don't know if there are any leveraged funds without a maximum interest rate - if so, avoid these. The Eaton Vance closed-end funds have a maximum rate (110% of higher of AA Commercial Paper or taxable equivalent short term muni obligation rate), so they should be little impacted by this.

But bottom line, this selling pressure in the muni market is unrelated to the long-term fundamentals of the market. So there are absolutely deals to be had if you look only to the long term.

2008 Mar 03 03:44 PM

[jcrash:]

Of course, if you expect 8 or 10% inflation and rates to match, you are better off somewhere else.

2008 Mar 03 04:41 PM

[zenalgorithm:]

Why? Because there is more risk. As long as property values keep declining, cities will take in less and less revenue - potentially endangering those muni bonds. I was thinking of moving into munis myself, but if this property deflation carries on too long...

2008 Mar 03 05:48 PM

[the_Bird:]

There's also a HUGE premium being paid for liquidity today. People want TREASURIES, nothing else will do. I sold an eighteen month Treasury note for a client today at a yield under 1.6%; there was no way we could walk away from the premium we were being paid on that bond. Retail client, I could sell the T at a 1.6% yield, buy an 18-month CD ~3.6%, and pick up 200bp for nothing more than giving up some liquidity (ended up doing some longer-term stuff in the muni market, but the point remains).

Unless the market thinks overnight rates are going to 50bp in the next year, T-rates as low as they are is purely a panic move. Everyone wants Treasuries, nothing else, because they are scared sh*tless of holding paper that they might have trouble getting a bid on in a few months. It's ALL about liquidity today.

2008 Mar 03 06:13 PM

[BondGuy:]

"As long as property values keep declining, cities will take in less and less revenue - potentially endangering those muni bonds. I was thinking of moving into munis myself, but if this property deflation carries on too long..."

REVENUES WILL NOT NECESSARILY FALL, SINCE MUNICIPALITIES CAN SIMPLY RAISE THE MILL RATE TO COMPENSATE FOR FALLING ASSESSMENTS. MOREOVER, EVEN IF THERE ARE FORECLOSURES, THE FORECLOSING BANK OR SUBSEQUENT OWNER WILL HAVE TO PAY THE BACK TAXES ON THE PROPERTY LIEN.

2008 Mar 03 06:20 PM

[Erich Riese...:]

I think the disparity shows Treasuires are too expensive, rather than Munis too cheap.

Municipalities can not simply raise the mill rate, it can be raised but eventually it won't be simple.

The standard refrain is muncipals never fail, similar to the quaint old refrain that house prices never fall.

I think municpal defaults will be low, with the default protection coming from inflation. Look at what is being done to prevent some foreclosures, imagine the effort which will be made to flood with dollars if municpal defaults appear imminent.

2008 Mar 03 07:47 PM

[Vladimir Se...:]

of course tax rate raises when values fall for the books to balance. so RE values should not be a major factor here.

2008 Mar 03 08:05 PM

[jahowle:]

The fact that some investors are concerned about falling property values when discussing the municipal bond market is exactly why we still see good value in this market. Is there a fear that municipal bond defaults could dramaticly increase to over 1%? Is that any reason to avoid bonds with the full faith and credit of the issuer, in the case of GO bonds, that have an 'A' or better underlying rating and some insurance or guarantee on top. If you are truly concerned about buying municipal bonds at these prices due to credit concerns you better bury your gold in the backyard and start hoarding food and water. If there is a concern about 8%-10% inflation then I hope you bought CIPs, corporate inflation protected bonds, when they were trading at a 400bps real rate of return. The municipal bond market does not offer big price dislocatons but about once every decade.

2008 Mar 03 09:04 PM

[Elliott:]

The City of Vallejo in California is on the verge of filing bankruptcy. To the people posting here that say that falling real estate is not a factor, I say you don't understand California. Tax rates on residential property are virtually locked in stone under Proposition 13. Unemployment in Calif has hit 6% and is rising.

If Vallejo files Chap 9 then other cities in California will follow suit. They too are caught in the same trap, falling property tax revenue and an inability to raise additional tax revenue. Sacramento is looking at deep layoffs right now.

The market doesn't give away free returns. The yields on munis is higher because the risk is higher.

2008 Mar 03 11:02 PM

[Topgun:]

You need to short the treasury to lock the spread, howeer, spread can go wider even (why not?), second, for a typical retail investor with even a buck, how much size can you do to achieve meaningful returns? Unless the yield goes to 10+ for the long term, I am not sure it's a screaming buy.

2008 Mar 03 11:35 PM

[crescent:]

1. Wall Street investment bank/brokerage lack of liquidity is causing them to pull back financing from some hedge funds, causing those that focus on municipal bonds to sell them- delevering.

2. That same liquidity problem has made the firms decide not to support auction-rate municipals like they usually do to clear imbalances between sellers/buyers, leading municipal issuers to go to the fixed-rate longer-term market to get reasonable interest rates- raising supply and cutting prices of existing bonds.

3. The economy stinks- municipal revenues are going down and reducing the credit quality of the bonds these municipalities issued

4. The bond guarantees many of these municipalities used to get AAA credit ratings and thus lower rates is ineffective now because the bond insurers are in trouble of losing their ratings- the bonds are trading as if they have no such insurance at all.

2008 Mar 04 12:01 AM

[Winston Kotzan:]

Munis may seem to have good value here, but don't fall for the long term value trap. There could be more to fall if we have an inflation catastrophe spurred by insanely low interest rates and stagflation.

2008 Mar 04 02:44 AM

[dukeb:]

Yup! That's just a little issue to consider if one believes that interest rates tend to function like warning signs.

2008 Mar 04 07:36 AM

[jahowle:]

When investing in any market there will be certain securities to avoid. California munis with poor underlying ratings would be one. Here in Texas real estate values are holding up very well. The same is true for many other areas as well. California is a unique market that seems to have always had it's own unique financial problems. You have to be selective but there are still some great values in the muni market.

2008 Mar 04 12:04 PM

[BondGuy:]

I would buy a Vanguard Muni Fund rather than individual bonds. You get their research and expertise at very low fees.

2008 Mar 04 06:41 PM

[mak1:]

Hi, I live in New York and am not sure what to buy; CTF s like PNF, PNI, PYN (I can't really figure out the differences) or a fund like FTMFX? Any insights or recommendations are appreciated!

2008 Mar 05 06:56 PM

[rkay48:]

I currently own NUV, which is a closed end fund that has NO leverage. It has been rising recently, and I assume this is because of a flight to quality and away from leverage, even in the Muni market. The average duration is relatively short (6+yrs), and the average credit rating is AA (but I do not know how many of the "AAA" bonds it holds are insured....). Not sure I would buy it here, because the discount to NAV has decreased to only 0.2%.
Also, as traders look for assets to sell, this will keep pressure on all "safe" types of bonds.

2008 Mar 07 11:39 AM