Bloomberg News

Tax-Exempt Debt in Longest Winning Streak Since ‘02: Muni Credit

September 30, 2011

Sept. 30 (Bloomberg) -- States and cities slashing borrowing to cut costs are driving the $2.9 trillion municipal- bond market to its sixth-straight month of positive total returns, the longest winning streak since 2002.

This year’s municipal sales totaled $165 billion as of Sept. 23, down about 40 percent from the period in 2010, according to data compiled by Bloomberg. At the same time, U.S. Treasuries have rallied, pushing down tax-exempt rates. Yields on top-rated municipals due in 10 years have fallen by 1.20 percentage points from the start of 2011.

While issuers including California and New York responded to declining interest rates by boosting total sales to $67 billion from July through this month, the biggest quarter since December, they’re unlikely to exceed last year’s record of $408 billion, when states and cities took advantage of the taxable Build America Bond program and its 35 percent federal subsidy on interest costs. The program ended Dec. 31.

“There’s been a light supply and strong demand,” Neil Klein, who manages $925 million at New York-based Carret Asset Management, said in an interview. “Numerous months in a row of positive returns are driven by that supply-and-demand dynamic.”

States and localities reduced borrowing earlier this year as they cut government payrolls and reduced spending to balance budgets. About three out of five municipalities in 2011 delayed or canceled capital infrastructure projects, according to a September survey from the National League of Cities.

“They have these projects that they intended to issue bonds for and they’re looking at them and reprioritizing,” John Bonnell, who manages $3.5 billion of municipal assets at USAA Investment Management Co., said in a telephone interview from San Antonio.

Defaults Decline

Municipal defaults have dropped this year to about $1.1 billion, a quarter of last year’s total, according to Bank of America Merrill Lynch. Meredith Whitney, the banking analyst who correctly predicted Citigroup Inc.’s dividend cut in 2008, told the CBS “60 Minutes” show in December that the next 12 months would see “hundreds of billions of dollars” of defaults.

Municipals have had “quite a run” this year because the “dire predictions” failed to materialize, Bonnell said.

“Having been beaten up in the fourth quarter, we were starting at a pretty low place,” Bonnell said. “So we had plenty of room to come up from there.”

Tax-exempt securities are on pace to gain 1.3 percent this month, following five consecutive months of positive returns, according to a Bank of America Merrill Lynch index that tracks prices and interest income. The last half-year stint was nine years ago.

Returns Outperform

Municipals are set to gain about 4 percent in the quarter ending Sept. 30, below Treasury gains of about 6 percent for the same period, the index shows. Tax-exempt bonds underperformed compared with federal debt because municipal rates did not fall as fast as Treasury yields, Klein said.

“Munis didn’t necessarily follow suit,” he said. “Yields didn’t go down as much, so they wouldn’t have kept pace from a performance perspective.”

Even so, tax-exempt bonds are outperforming Treasuries this year. Municipals returned 8.9 percent as of Sept. 29, compared with the 8.6 percent gain for Treasuries.

On a relative basis munis are still cheaper than Treasuries because U.S. government yields have fallen faster. The ratio of 30-year tax-exempt rates to those of 30-year Treasuries was 115 percent yesterday, after reaching a 2011 high of 126 percent on Sept. 22, according to Bloomberg data.

“If you look at municipal yields compared to the other fixed-income alternatives, we still look very, very cheap,” Bonnell said.

--Editors: Walid El-Gabry, Mark Schoifet

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net


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