Bloomberg News

Taxable Bonds Trail Companies on Risk: Muni Credit

October 31, 2011

(Corrects amount of BABs outstanding in 11th paragraph of article published Oct. 28.)

Oct. 28 (Bloomberg) -- Taxable municipal bonds, whose return is double that of tax-exempts this year, are set for their worst month of 2011 and are losing ground to company debt as investors reacquire a taste for risk.

Taxable munis lost 3.2 percent this month, their only negative return of 2011 after a 1.2 percent retreat in June, according to Bank of America Merrill Lynch indexes that track price changes and interest payments. Company debt earned 0.44 percent in October, the most since 2.3 percent in July.

Investors seeking higher yields propelled company debt after concerns eased about European bond defaults, said Mikhail Foux, a credit strategist at Citigroup Inc. National leaders agreed on a plan to ease Greece’s debt burden yesterday, pushing up stocks worldwide and putting the Standard & Poor’s 500 Index on course for its biggest monthly rally since October 1974.

“Taxable munis are sort of like an orphan asset class and they tend to lag the move in the corporate space,” Foux said in a telephone interview from New York. “In this rally, I would expect them to lag initially until they catch up to the corporate market down the line.”

Taxable munis returned 15.8 percent in 2011 compared with 6.1 percent for corporates and 8.1 percent for all municipal debt, according to the Bank of America Merrill Lynch Indexes.

This week, yields on top-rated corporates fell 4 basis points to 3.95 percent Oct. 26, according to the Moody’s Corporate Bond Index. They rose as high as 4.13 percent Oct. 12.

Diverging Yields

Top-rated 10-year taxable muni yields rose 1 basis point this week through yesterday to 3.56 percent, according to a Bloomberg Fair Value index. They were as low as 3.47 percent on Oct. 6. A basis point is 0.01 percentage point.

Yields on top-rated 10-year tax-exempts closed at 2.39 percent yesterday, down from 2.58 percent on Oct. 13, the highest since Aug. 2. Yields on 10-year U.S. Treasuries climbed as high as 2.41 percent, the most since Aug. 9.

The ratio of 10-year AAA municipal debt yields to rates on similar-maturity Treasuries fell to 100.5 percent yesterday, the lowest since Sept. 15, according to data compiled by Bloomberg.

Interest in taxable municipals grew with the creation of the Build America Bonds program in the U.S. economic stimulus package of 2009. The federal government provided state and local borrowers a 35 percent subsidy of their interest costs on the taxable debt during the 20-month program that ended in December.

About $188 billion of Build America Bonds were sold, according to data compiled by Bloomberg. There are about $300 billion of taxable municipal bonds outstanding, according to Alan Schankel, director of fixed-income research for Janney Montgomery Scott LLC in Philadelphia. That’s about a tenth of the $2.9 trillion municipal market.

New Investors

“The advent of BABs created a new class of investor for municipal bonds, with demand coming from pension funds, non-U.S. institutions and other entities which did not previously consider municipals since they had little need for tax-exempt income,” Schankel said in an Oct. 24 report.

The difference in yield between BBB rated taxable munis and similar corporates widened to as much as 213 basis points in August as investors fled high-risk debt amid speculation about European defaults. It’s now about 84 basis points, the lowest since April.

Taxable munis and corporate bonds compete for the same buyers, said Justin Hoogendoorn, managing director of the strategic analytics group at BMO Capital Markets in Chicago.

Returns on taxable munis will bounce back later this year because “additional negative headlines out of Europe” will depress riskier assets, he said.

Other Side

“October might be pretty much sealed at this point,” Hoogendoorn said. “I’d take the other side in November and December.”

Municipal bonds default less than company debt, according to Moody’s Investors Service. The average default rate for Moody’s-evaluated investment-grade munis in the five years after issuance from 1970 through 2009 was 0.03 percent, compared with 0.97 percent for similar corporate issues, the company said in a report last year.

A rally in taxable municipals would help Puerto Rico’s Government Development Bank, which has yet to price a $500 million sale of taxable debt it had planned for the fourth quarter.

“It’s predominantly a refunding for savings,” Jose Otero, vice president of financing for the bank, said in a telephone interview from San Juan, the capital. “When we decide to do it, we have to make sure that the savings are there.”

Following are descriptions of coming sales of municipal bonds:

CONNECTICUT, the wealthiest U.S. state by personal income, will sell $550 million of tax-exempt general-obligation bonds as soon as next week, according to a preliminary official statement. Fitch Ratings grades the bonds AA and Moody’s rates them Aa2, both third-highest. JPMorgan Chase & Co. will lead the deal. (Added Oct. 28)

CALIFORNIA STATE PUBLIC WORKS BOARD, which finances capital projects, will sell $503 million of lease revenue bonds as soon as next week to build three courthouses, according to a preliminary official statement. Moody’s rates the bonds A2, sixth-highest. RBC Capital Markets will lead a syndicate of banks on the deal. (Added Oct. 28)

STATE OF NEW YORK MORTGAGE AGENCY, which bought 2,110 home loans in fiscal 2010, will sell $168.6 million of revenue refunding bonds as soon as next week, according to a preliminary official statement. The sale will include $118.6 million of federally taxable debt. Moody’s rates the sale Aa1, second- highest grade. Citigroup Inc. will lead banks marketing the debt. (Added Oct. 27)

GEORGIA, one of only eight states with S&P’s AAA rating, will sell $400.8 million of general-obligation bonds as soon as next week through competitive bid, according to a preliminary official statement. The sale includes $153.8 million for refunding. (Added Oct. 27)

--Editor: Jerry Hart, Ted Bunker

To contact the reporters on this story: Michelle Kaske in New York at Simone Baribeau in Miami at;

To contact the editor responsible for this story: Mark Tannenbaum at

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