| Bonds Online |
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| 5/10/2013Market Performance |
| Municipal Bonds |
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S&P National Bond Index
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3.00% |
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S&P California Bond Index
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2.96% |
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S&P New York Bond Index
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3.13% |
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S&P National 0-5 Year Municipal Bond Index
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0.70% |
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| S&P/BGCantor US Treasury Bond |
400.09 |
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| Preferred Stocks |
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S&P U.S. Preferred Stock Index
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848.03 |
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S&P U.S. Preferred Stock Index (CAD)
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636.26 |
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S&P U.S. Preferred Stock Index (TR)
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1,701.05 |
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S&P U.S. Preferred Stock Index (TR) (CAD)
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1,276.26 |
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| REITs |
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S&P REIT Index
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174.07 |
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S&P REIT Index (TR)
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425.30 |
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| MLPs |
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S&P MLP Index
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2,469.58 |
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S&P MLP Index (TR)
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5,428.50 |
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See Data
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Defaults Signal Bursting Muni Junk Bubble After Surge |
By Margaret Collins
March 10 (Bloomberg) -- Investors in search of better returns poured $7.8 billion into high-yield municipal bond funds last year, pushing assets to a two-year high. They may start experiencing losses as early as this year as default risks grow.
“People are starving for yield because rates are at zero,” said Paul Tramontano, co-chief executive officer of New York- based Constellation Wealth Advisors, which manages about $4 billion. “They’re taking more risk than they think.”
Below-investment grade munis are typically issued by companies raising debt through a municipality for a project with a public interest such as hospitals, nursing homes, housing developments and sports stadiums, said Eric Jacobson, director of fixed-income research for Morningstar Inc.
“In order to be muni-junk, you really have to be junk,” said Gary Pollack, who helps oversee $12 billion as managing director of fixed income for Deutsche Bank AG’s Private Wealth Management unit in New York. “I wouldn’t touch them.”
High-yield municipal bonds rated BB+ or lower by Standard & Poor’s or Ba1 by Moody’s Investors Service, one level below investment-grade debt, have returned about 31 percent in the last 12 months compared with 11 percent for investment-grade municipal securities, according to the indexes from S&P/Investortools.
Revenue Decline
U.S. state and local government tax revenue fell 6.7 percent as of September from a year earlier, marking the fourth consecutive quarter of decline, according to a December Census Bureau report. That may drive defaults higher this year and next, according to Moody’s, which didn’t provide a number. The New York-based company also said it expects “somewhat higher rates of default” among bonds not rated and those below investment-grade.
Health care and housing have suffered from the recession and weak economy, said Anne Van Praagh, a Moody’s analyst. “And their ratings are at lower levels,” she said.
“While high-yield, tax-exempt funds may look like a great opportunity, people better be very wary of getting in there now,” said Michael Janik, senior credit analyst for the Virtus Tax-Exempt Bond Fund of Virtus Investment Partners Inc. “They could be burned.” The Hartford, Connecticut-based firm doesn’t buy below investment-grade municipal bonds.
Rising taxes are also driving investors to munis, said Jim Rosenkoetter, a fixed-income portfolio manager for Chicago-based Talon Asset Management, whose average client has $3 million to $5 million. That’s because the bonds are generally exempt from federal taxes as well as state and local levies for residents in most states where they’re issued, he said.
Higher Returns
Nine states raised personal income taxes last year including California, Connecticut, New York and New Jersey, according to the Washington-based Tax Foundation. President Barack Obama has proposed raising the top income tax rate on joint filers earning more than $250,000 to 39.6 percent next year from 35 percent.
“If they go to a 40 percent tax bracket, a 7.25 percent yield from a high-yield municipal bond fund is the equivalent of 12 percent taxable yield,” said John Miller, who manages a $4.5 billion high-yield municipal bond fund for Chicago-based Nuveen Asset Management. “Where are you going to get that type of potential return?”
The Nuveen High Yield Municipal Bond Fund is about 80 percent invested in bonds rated BBB and below, Miller said.
Most Since 2007
High-yield municipal bonds due in 8 years to 12 years were yielding an average 6.63 percent last month, almost double the 3.42 percent on similar maturity bonds in the broader tax-exempt market, according to Barclays Capital indexes. The average dividend yield on a stock in the Standard & Poor’s 500 Index was 1.98 percent on March 9 and the average interest on a taxable money market fund was 0.02 percent as of March 2.
High-yield municipal funds had $49.3 billion in assets as of January, the most since November 2007, according to Morningstar. Those are portfolios holding at least 50 percent in municipal debt rated BBB and below, according to the Chicago- based research firm. They attracted an estimated $7.8 billion in 2009, the most since 2006, according to Morningstar.
Individual investments in municipal debt, either directly through broker-dealers or mutual funds, accounted for more than half of the overall $2.8 trillion market as of the third quarter last year, according to Federal Reserve data. The Fed does not break down the number of households holding below investment- grade bonds.
Default Risk
Investors buying lower-rated issues risk not receiving interest payments, losing their principal or having to sell the securities at a discount, said Lynnette Kelly Hotchkiss, executive director of the Municipal Securities Rulemaking Board, the market’s self-regulator based in Alexandria, Virginia.
The risk of municipal-bond defaults in the future is “higher than it’s been in quite some time,” said Deutsche Bank’s Pollack, because of the unprecedented stress on state and local budgets. From 1970 to 2009, the average five-year default rate was 3.43 percent for speculative-grade debt, Moody’s said. Harrisburg, the capital of Pennsylvania, has considered filing for reorganization under Chapter 9 of the U.S. bankruptcy code as it faces $68 million in debt.
About $2.4 billion of Florida’s so-called dirt bonds, or debt to finance real-estate developments, used reserves or failed to make interest payments in November, up from $1.7 billion in May, according to Interactive Data Corp. That’s the largest amount on record and “reflects an increasing trend,” said Edward Krauss, an analyst for the Bedford, Massachusetts- based research firm, in an e-mail.
Taxing Authority
State and local governments can raise taxes and cut services to continue to pay the interest and principal on their debts, said Scott Cottier, who oversees the $6.4 billion Oppenheimer Rochester National Municipals fund of New York-based OppenheimerFunds Inc. It had a 44 percent total return in the past 12 months, the most among high-yield municipal funds, according to Morningstar.
“The fear of defaults is over-baked in the muni market,” Cottier said.
The Oppenheimer fund has fluctuated the past four years, declining 60 percent from December 2006 to December 2008 and then regaining 39 percent as of February, according to Bloomberg data. That means an investor lost 44 percent during that time period.
Price volatility is as important for retail investors to understand as the potential for default, said Josh Gonze, who helps manage about $4 billion of municipal bonds including a high-yield fund for Thornburg Investment Management Inc., based in Santa Fe, New Mexico.
Mitigate Risk
“Let’s say one nursing home bond goes bad and then the price on similar bonds in that category decline in value,” he said. “The bonds may never default, but the market value of the account has declined.”
A fund manager mitigates risk by diversifying across states, industries and maturities, Gonze said. Sixty-three percent of the Thornburg Strategic Municipal Income Fund, which holds debt from 100 different issuers, are rated BBB and below, the company said.
Assessing the credit quality of high-yield, high-risk municipal bonds may be harder than similar corporate junk bonds because fewer Wall Street analysts review them, said Deutsche Bank’s Pollack. The bonds also tend to be less liquid because they don’t trade as often, he said.
Investors should do their own research before buying a more speculative bond, said Hotchkiss of the Municipal Securities Rulemaking Board. The MSRB Web site provides trade data, financial statements and disclosures for free.
“Make sure you understand the credit of the issuer, the source of repayment for the bond and the priority of repayment,” Hotchkiss said. When investing through a mutual fund, find out the parameters for the credit quality of the fund’s bonds and the manager’s investment strategy, she said.
“Where I get worried is when Mom and Pop get interested in chasing yield,” Hotchkiss said. “It’s very intoxicating.”
--With assistance from Jeremy Cooke in New York. Editors: Rick Levinson, William Glasgall, Rob Urban.
To contact the reporter on this story: Margaret Collins in New York at mcollins45@bloomberg.net.
To contact the editor responsible for this story: Rick Levinson at rlevinson2@bloomberg.net.
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