Bloomberg News

Yields Still Above Treasuries Help Perpetuate Rally: Muni Credit

October 24, 2011

Oct. 24 (Bloomberg) -- The $2.9 trillion market for municipal debt may be poised for its biggest rally since August as investors are drawn to tax-free bonds with yields that have been above Treasury interest rates for the longest stretch in two years.

Yields on top-rated municipal debt due in 10 years fell 15 basis points last week, the most since early September, to 2.42 percent, according to data compiled by Bloomberg. A basis point is 0.01 percentage point. The bonds rose as issuance showed the smallest weekly gain in more than a month.

Ten-year municipal yields haven’t declined two straight weeks since August. The rates are about 109 percent of those on Treasury notes of that maturity, down from a two-year high of 123 percent on Oct. 6. The ratio has exceeded 100 percent since Aug. 30, the longest span since 2009.

“You have taxable-equivalent yields and absolute yields that look very attractive,” said Neil Klein, who manages $925 million at New York-based Carret Asset Management, in an interview. “There’s no reason that demand would wane.”

Chicago’s transit system and California join issuers planning a combined $7.8 billion of sales this week, after borrowing totaled $8.9 billion in the five days ended Oct. 7, the most this year. Local governments are seeking to sell with yields close to the lowest level since the 1960s, according to a Bond Buyer index going back to 1961. October issuance may swell to $32 billion, the biggest month of 2011, Bloomberg data show.

Money Flowing In

At the same time, investor confidence in the securities is growing as municipalities are defaulting at less than a third of last year’s pace, according to the Distressed Debt Securities Newsletter. Defaults totaled $949 million through September, compared with $3.4 billion for all of 2010, said the newsletter, published by Miami Lakes, Florida-based Income Securities Advisor Inc.

Investors added about $417 million to U.S. municipal-bond mutual funds in the week through Oct. 19, according to Lipper US Fund Flows. The net gain of $2.3 billion in the past seven weeks was the biggest inflow in a year, Lipper data show.

“There’s a green light for getting into munis as our models continue to show value in the market,” said Justin Hoogendoorn, managing director in the strategic analytic group at BMO Capital Markets in Chicago, in an interview.

“If issuance continued to climb to something closer to $10 billion, then I’d be worried,” Hoogendoorn said. “But below $8 billion, I think it’ll be well-absorbed into the market.”

2011 Returns

Municipal debt has returned 8.3 percent this year, beating the 7.6 percent earned in Treasuries, according to Bank of America Merrill Lynch index data. Corporate securities have earned 5.8 percent.

Peter DeGroot at JPMorgan Chase & Co. said that tax-exempts are attractive relative to both Treasuries and corporate debt. Investors should overweight securities from some airports, toll roads and electric utilities, DeGroot, a municipal strategist at the bank, said in an Oct. 21 report.

In this week’s biggest deal, the Massachusetts School Building Authority plans to issue $600 million of sales-tax- backed bonds to fund construction and repairs.

Improving tax revenue has contributed to this month’s swollen borrowing after issuance slumped at the start of 2011, Hoogendoorn said. State and local tax revenue rose 6.9 percent in the second quarter, the seventh straight period of growth, according to U.S. Census Bureau data. Collections are recovering in the wake of the 18-month recession that ended in June 2009.

Following the year-end expiration of the Build America Bonds program, which gave issuers a federal subsidy on interest payments, municipal sales fell to $172 billion in the first three quarters of the year, a drop of about 40 percent from the same period in 2010, Bloomberg data show.

Issuance may be set to fade after this month. For the next 30 days, states and local governments have $7.3 billion of sales planned, the least since Sept. 9, according to the Bloomberg 30- Day Visible Supply index.

Following are descriptions of pending sales of U.S. municipal debt:

MICHIGAN FINANCE AUTHORITY, which was created last year by combining 10 public finance authorities, plans to sell $294 million of tax-exempt revenue-refunding bonds as soon as this week, according to a preliminary official statement. About 80 percent of the sale will finance the authority’s clean-water revolving fund program, and the remainder will go toward the drinking-water revolving fund. Bank of America Merrill Lynch will lead the sale. The bonds carry Standard and Poor’s top grade. (Added Oct. 24)

CHICAGO TRANSIT AUTHORITY, the nation’s second-largest public-transport system, plans to sell $559.7 million of debt, including $455 million of sales-tax revenue bonds for rail cars and capital improvements, as soon as this week, according to a preliminary official statement. Wells Fargo Securities will lead a syndicate of banks. The bonds are rated AA by Standard & Poor’s, its third-highest grade. (Updated Oct. 24)

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 this week, according to a preliminary official statement. The bonds will fund local school construction and repairs. Barclay’s Capital will lead 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 this week, according to a preliminary official statement. The debt will fund infrastructure, educational and vocational projects and provide incentives for businesses to hire workers in the state. The bonds carry S&P’s top AAA grade. (Added Oct. 19)

--Editors: Mark Tannenbaum, Mark Schoifet

To contact the reporters on this story: Andrea Riquier in New York at ariquier@bloomberg.net; 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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