Painful as the credit crisis has been to many people, it's become a boon to at least one group: municipal bond investors.
Muni bonds — issued by states, cities and municipal authorities — offer interest that's free from federal income tax and sometimes from state and local taxes, too. Normally, muni yields are lower than Treasury bond yields and so make a smart investment mainly for people in a high tax bracket.
But munis are now yielding more than Treasury bonds, making them attractive even if you pay no federal taxes. It's something that's happened just twice — and briefly — since 1990.
"Munis are a great value," notes Dave MacEwen, chief investment officer for fixed income at American Century Investments.
Example: A five-year, top-rated muni bond yields 3.16%, according to Bloomberg. That compares with 2.84% for a five-year T-note.
And when you factor in the effect of federal taxes, the muni is even more attractive. Say you're in the 25% tax bracket. You'd need that 2.84% five-year T-note to yield 4.21% to earn the equivalent of the muni's 3.16% after federal taxes.
Timothy Pynchon, co-manager of the Pioneer Tax-Free Income fund, notes that as the subprime crisis has deepened, investors have stampeded to the safety of Treasury securities, thereby driving Treasury yields lower.
When demand for Treasuries rises, the government can offer lower rates on its ultrasafe bills, notes and bonds. The yield on the three-month T-bill, for instance, has sunk from 3.29% Dec. 31 to 2.85% on Friday.
Big institutional investors, which aren't concerned with taxes, ignored the muni market, so demand hasn't increased as much there — so yields haven't fallen as much. "Munis got left behind," Pynchon says.
The troubles of two municipal bond insurers — Ambac and MBIA — have also helped keep muni bond yields high. Muni bond issuers buy default insurance to try to get higher credit ratings and lower yields for their bonds. Investors demand higher yields from issuers when they detect a higher risk of default.
Muni bond insurers have also been clobbered by losses from their investments in mortgage-backed securities. Last week, Ambac fired its CEO, cut its dividend and said it expected a net loss per share of up to $32.83 for the fourth quarter of 2007. Fitch Ratings cut Ambac's financial strength rating on Friday.
But municipal defaults are rare. Only about 0.3% of investment-grade munis default each year, compared with 2.1% of investment-grade corporate bonds, says American Century's McEwen. Many insured munis have seen their yields rise to the levels they would be if they had no insurance at all, McEwen says.
