Bloomberg News

Local Debt Cheap to Treasuries Longest Since 2009: Muni Credit

July 16, 2012

San Bernardino Bankruptcy

San Bernardino Mayor Pat Morris regarding the city council vote authorizing a bankruptcy filing outside City Hall. Photographer: Rick Sforza/The San Bernardino Sun/AP Photo

Municipal debt is set to remain cheaper than Treasuries for the longest stretch in three years, signaling a buying opportunity to Janney Montgomery Scott LLC and Samson Capital Advisors LLC.

Yields on tax-exempt bonds maturing in 10 years have been above their federal counterparts since mid-May, the lengthiest span since September 2008 through May 2009, data compiled by Bloomberg show. Investors have been favoring Treasuries as a haven from Europe’s debt crisis, a slowing economy and spreading municipal bankruptcies in California.

The benchmark yield on 10-year munis touched 1.77 percent last week, the lowest since mid-May, according to Bloomberg Valuation data. Yet it was still as much as 125 percent of the interest rate on similar-maturity Treasuries, close to a three- year high.

“No question that municipals represent a far better value than the high-grade taxable markets,” said Ken Potts, who manages about $1 billion of munis at Samson in New York. The company has been exiting taxable securities in the past few months and “trying to put that money to work in munis,” he said.

With state revenue rising for nine straight quarters in the wake of the longest recession since the 1930s and defaults on the decline, tax-free bonds are proving a haven. After adjusting for volatility, the $3.7 trillion muni market is on a pace to beat Treasuries and corporate debt for a second straight year.

Yields Tumble

Yields on top-grade munis due in 10 years sank last week by the most since March, according to a Bloomberg Valuation index. Benchmark 10-year Treasury yields touched about 1.45 percent, within 0.02 percentage point of a record low.

The yield on AAA 10-year munis is equivalent to about a 2.7 percent taxable rate for investors in the highest tax bracket.

“It’s a lot easier to digest these nominal yields when they have such attractive ratios to Treasuries,” said Tom Boylen, a trader at Chicago-based Performance Trust Capital Partners, which invests in fixed-income securities. “The longer we stay down at these levels, the more money that will come off the sidelines” into munis, he said.

The decisions by three California municipalities in as many weeks to seek bankruptcy protection are contributing to elevate the ratio, said Alan Schankel, a managing director at Janney in Philadelphia.

Bankruptcy Decisions

On July 10, San Bernardino’s City Council voted to file for protection, following moves by Stockton and the town of Mammoth Lakes since the end of June.

Surging municipal issuance has also limited the drop in local-government interest rates. Issuers have been taking advantage of yields close to the lowest since the 1960s to refinance higher-cost debt, boosting supply by more than 70 percent this year over the same period in 2011, data compiled by Bloomberg show.

Demand for muni mutual funds hasn’t been damped by the fiscal crises in California. The funds added about $653 million in the week through July 11, the most since mid-May, Lipper US Fund Flows data show.

Individual-investor clients are finding tax-free debt “more attractive and we’re telling them that it’s more attractive on a relative basis,” said Schankel at Janney. “No one likes the low yields.”

The elevated ratio may persist through 2012, according to John Hallacy, head of municipal research at Bank of America Merrill Lynch in New York.

“It’s going to go straight to the end of the year, post- election,” in part because of the looming debate among federal lawmakers on how to shrink the nation’s deficit, he said.

The ratio of muni yields to federal interest rates, a measure of relative value between the two asset classes, has averaged about 92 percent since the start of 2001, data compiled by Bloomberg show. It reached a peak of about 195 percent in December 2008.

Following are pending sales:

DORMITORY AUTHORITY OF THE STATE OF NEW YORK plans to sell $1 billion of debt backed by personal-income-tax revenue as soon as July 17 through competitive bid, according to bond documents. Proceeds will help finance capital projects for the State University of New York system and the City University of New York and support environmental infrastructure projects. (Updated July 13)

MIAMI-DADE COUNTY, Florida, is set to issue $540 million of revenue bonds as soon as this week. The sale will refund debt and help finance transportation projects, according to bond documents. (Updated July 13)

To contact the reporters on this story: Gillian White in New York at gwhite46@bloomberg.net; 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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