Bloomberg News

Default-Prone Projects With 8% Yield Lure Investors: Muni Credit

October 20, 2011

Oct. 20 (Bloomberg) -- Investors hunting higher yields are turning to securities that make up 17 percent of municipal bond sales while generating almost half the defaults.

Tax-exempt conduit bonds -- sold by governments for private companies, hospitals and non-profits -- due in 10 years yielded 1.06 percentage points more than top-rated general-obligations yesterday. That’s down from a one-year high of 1.34 percentage points last month, according to data compiled by Bloomberg.

Investors are ignoring the largest municipal-bond default this year and speculation about a bankruptcy by American Airlines parent AMR Corp., a backer of conduits sold by U.S. airports. They’re willing to take the risk for yields as high as 8 percent, said Tim Pynchon, who helps oversee $4 billion of municipal bonds at Boston’s Pioneer Investment Management Inc.

“You’re being well-compensated for what are typically well-thought-out projects,” said Pynchon. “From a value standpoint, that sector is very interesting.”

Jefferson Parrish Hospital Service District No. 2 in Louisiana sold $170 million of debt this week for East Jefferson General Hospital, a 420-bed facility outside New Orleans. A tax- exempt security due in July 2041 rated BBB- by Standard & Poor’s, one level above junk, was priced to yield 6.5 percent.

That translates into a 10 percent return for someone in the 35 percent income-tax bracket. Taxable Treasury bonds maturing in 30 years yielded about 3.2 percent yesterday.

“There’s a lot of value in taxable-equivalent yield,” said John Miller, co-head of fixed-income at Chicago-based Nuveen Asset Management, which supervises $100 billion.

Public Issuers

State and local governments issue tax-exempt bonds for non- government borrowers such as airlines building airport facilities or non-profit developers of senior housing. That allows private entities to borrow at lower tax-exempt rates.

The government lends only its name to the bond sale and doesn’t pledge any of its own revenue, which means the repayment depends solely on the borrower, known as the obligor.

Conduits made up just 17 percent of the $2.3 trillion of municipal bonds sold since 2007, according to data compiled by Bloomberg. Still, almost half of the 78 defaults this year have been conduits, according to Matt Fabian, managing director with the Concord, Massachusetts-based research firm Municipal Market Advisors. Only one general-obligation bond defaulted, according to Fabian: Brighton, Alabama, a city of 2,945 near Birmingham.

Largest Default

The largest municipal default this year was for conduit bonds of the Clare at Water Tower, a 53-story housing development for retirees in Chicago with about $229 million of long-term debt. It missed a Sept. 1 payment after occupancy failed to meet expectations.

Bonds for the property, developed by the Franciscan Sisters of Chicago Service Corp., were issued for Clare by the Illinois State Finance Authority. The agency has financed 496 projects worth $25 billion, according to its website.

Conduits can include top-rated, junk and unrated bonds, so investors have to research deals individually, Pynchon said.

“You need to do the analysis,” he said. “Particularly if you’re talking about high yield -- a lot of times ratings aren’t available.”

Each issue has its own revenue, security and legal protections that can affect the ultimate payout and recovery for holders.

“There is opportunity if you do your homework,” said Richard Ciccarone, managing director of McDonnell Investment Management in Oak Brook, Illinois. “Not all conduit issues are risky.”

Bankruptcy Speculation

Bonds backed by AMR’s American Airlines for airport facilities fell earlier this month on concern that the third- largest U.S. carrier may be forced to seek bankruptcy protection as it heads for its fourth consecutive annual loss.

A Chapter 11 filing “is certainly not our goal or our preference,” Andy Backover, an American spokesman, said on Oct. 3, the day AMR’s shares plunged the most since 2001 on the speculation.

An American-backed bond sold by Dallas-Fort Worth International Airport traded at an average of about 81 cents on the dollar on that day, down from about 98 cents Sept. 23.

Following is a description of pending sales of municipal debt:

HOWARD COUNTY, Maryland, with the third-highest U.S. median household income, plans to sell about $194 million of general- obligation bonds as soon as next week through competitive bid, according to a preliminary official statement. The county issued $160 million of debt in February and is selling again in part to finance its April purchase of the Ascend One building in Columbia, Maryland. The bonds are rated AAA, the highest from Standard & Poor’s. (Added Oct. 20)

MASSACHUSETTS SCHOOL BUILDING AUTHORITY, with $648 million of general revenue last fiscal year, will sell $600 million of senior sales-tax bonds as soon as next week, according to a preliminary official statement. The bonds will fund local school construction and repairs. Barclay’s Capital will lead a syndicate of banks. (Added Oct. 20)

ILLINOIS, which approved the biggest tax increase in state history to close a deficit this year, plans to sell $300 million of Build Illinois sales-tax revenue bonds by competitive bid as early as next week, according to a preliminary official statement. The program will fund infrastructure, educational and vocational projects and provide incentives for businesses that plan to hire workers in the state. The bonds are rated AAA by S&P, the top grade. (Added Oct. 19)

--With assistance from Sowjana Sivaloganathan and Brian Chappatta in New York and Mary Schlangenstein in Dallas. Editors: Jerry Hart, Mark Tannenbaum

To contact the reporters on this story: Darrell Preston in Dallas at dpreston@bloomberg.net Andrea Riquier in New York at ariquier@bloomberg.net

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


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