Bloomberg News

Munis Prove Mighty Over All Assets for Second Year: Muni Credit

July 10, 2012

U.S. state and local debt is on its way to beating stocks, Treasuries, corporate bonds and commodities for a second straight year when adjusting for volatility, the longest win streak since 2006.

With defaults declining and tax revenue improving, the $3.7 trillion municipal market is proving the safest haven amid Europe’s debt crisis and signs of slowing global economic growth. Part of the reason is who owns city and state debt: Federal Reserve data show about two-thirds is in the hands of individual investors, who are less inclined to shift assets between world markets.

“Munis do get more of this tranquility, because just as they don’t enjoy the global flows in, they don’t succumb to the outflows,” said John Dillon, chief municipal strategist in Purchase, New York, at Morgan Stanley Smith Barney, which manages more than $150 billion in state and local debt.

Municipal debt has returned 2.2 percent this year through July 6 after accounting for trading swings, according to data compiled by Bloomberg and Bank of America Merrill Lynch. Company bonds have earned 1.6 percent by that measure, compared with about 0.7 percent for both the Standard & Poor’s 500 (SPX) Index and Treasuries. Commodities generated a loss. In 2010, munis trailed the group.

Investors seeking tax-exempt income have added $15.7 billion this year to municipal mutual funds, the most for the period since 2009, Lipper US Fund Flows data show. Bondholders are putting to work a record wave of about $142 billion in the three months through July from bonds that are coming due or being refinanced, according to Citigroup Inc.

Risk Adjustment

City and state debt also gave better risk-adjusted returns in 2011. The securities gained about 4.4 percent last year when adjusted for volatility, even as investors withdrew the most money in two decades from muni mutual funds on concern that fiscal stress following the 18-month recession that ended in June 2009 would push up local defaults.

About $17 billion flowed out of the funds in 2011 after banking analyst Meredith Whitney predicted in a December 2010 broadcast of CBS Corp.’s “60 Minutes” that municipal defaults would total “hundreds of billions of dollars” in the coming year.

Instead, state tax collections have risen for nine straight quarters, according to the Nelson A. Rockefeller Institute of Government in Albany, New York. The boost has helped trim first- time defaults to 39 issuers in the first half of this year, compared with 57 in the same period of 2011, according to Municipal Market Advisors.

Default List

“It’s a comfort to investors that defaults and bankruptcies don’t appear rampant and don’t appear to be headed that way,” Dillon said. “Other than the names everyone knows about in the marketplace, there are very few new names getting added to that list.”

Stockton, California, became the biggest U.S. city to file for Chapter 9 protection in June. The housing market’s collapse left the city of 292,000 with mounting retiree health-care costs and an eroding tax base in the recession’s wake, while accounting errors overstated municipal revenue. Its budget for this year calls for withholding $10.2 million in debt service.

The development hasn’t pushed up local-government yields. Since Stockton filed, the yield on 10-year AAA debt has declined by about 0.02 percentage point, according to a Bloomberg Valuation index.

Safe Class

“Munis are still seen as a fairly safe investment class by retail investors, even with all the headlines,” said Craig Pernick, a Bethesda, Maryland-based senior managing director at Chevy Chase Trust Co., which oversees about $1.1 billion in municipals. “When you compare them to Europe and the rest of the world, municipalities look pretty good.”

Ten-year Treasury yields hovering near record lows on indications the economic rebound is cooling have helped suppress interest rates on munis.

The International Monetary Fund will lower its estimate for global growth this year on weakness in investment, jobs and manufacturing in areas including Europe, the U.S. and Brazil, Managing Director Christine Lagarde said last week.

The ratio of muni interest rates to federal yields has been above 100 percent since May 16, the longest span since October, data compiled by Bloomberg show. The ratio has averaged about 93 percent for the past decade.

“A lot of times muni rates haven’t moved as much, but the Treasuries have moved more,” said John Hallacy, head of muni research at Bank of America in New York. “That’s what’s moving the Treasury ratios around -- Treasuries dancing around munis.”

The risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. The returns aren’t annualized. Higher volatility means an asset’s price can swing dramatically in a short period, increasing the prospect for unexpected losses.

Following are pending sales:

ILLINOIS plans to issue about $1.5 billion in revenue bonds for its unemployment-insurance fund as soon as next week, according to an offering document. The proceeds will repay federal government advances. S&P rates the debt AA, third- highest. (Updated July 10)

METROPOLITAN TRANSPORTATION AUTHORITY plans to offer $500 million of revenue bonds as soon as this week to help finance capital projects. Moody’s Investors Service rates the sale A2, sixth-highest. (Added July 6)

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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