Bloomberg News

Riskiest Debt Safest as High-Yield Rises From Worst: Muni Credit

September 05, 2012

High-yield municipal debt, the best- returning part of the $3.7 trillion U.S. local-bond market in 2012, is also turning out to be the safest for the first time in six years.

City and state securities rated below investment grade are beating the market on an absolute basis and when adjusted for volatility, according to data compiled by Standard & Poor’s and Bloomberg. It’s a reversal of 2011, when the bonds proved the riskiest.

Investors’ quest for a haven from global credit strains has fueled more trading in high-grade munis than in low-grade, said Daniel Solender at Lord Abbett & Co. The extra yield on lower- rated debt has drawn buyers as interest rates on U.S. Treasuries and munis set record lows.

“A lot of volatility is coming from global interest-rate moves,” said Solender, who helps manage the $1.9 billion Lord Abbett High-Yield Municipal Bond Fund (HYMAX:US) in Jersey City, New Jersey. “And that’s more directly affecting the movement of high-quality municipals.”

Speculative-grade local bonds are those rated Ba1 or lower by Moody’s Investors Service and BB+ or below by S&P. The securities have earned 7.6 percent this year when accounting for price swings, compared with a 3.5 percent risk-adjusted gain for the broader market and better than all other tax-exempt areas, according to data compiled by S&P and Bloomberg.

On an absolute basis, high-yield’s 13.3 percent earning outpaces the market’s 6 percent. The last time they were the safest segment of munis was in 2006.

Individuals’ Control

Individuals, who own about 70 percent of munis either directly or through mutual funds, have looked to high-yield even though the lower-rated bonds tend to default more often. From 1970 to 2011, an average of 7.9 percent of munis that were sold a decade or more earlier and had a junk rating from Moody’s defaulted, compared with 0.08 percent for investment grade.

U.S. municipal high-yield funds have added $5.9 billion of assets this year, after investors withdrew about $33 billion in the same period of 2011, Lipper US Fund Flows data show.

The risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation. The result gives a measure of income per unit of risk. The returns aren’t annualized.

Demand Climbs

“There’s a lot more demand for income with interest rates so low, and people are a little reticent to take equity risk,” said Guy Davidson, director of muni investments at AllianceBernstein LP in New York. He helps oversee the firm’s $1 billion High Income Municipal Portfolio. (ABTHX:US)

In trading yesterday, yields on AAA munis maturing in 10 years were little changed close to a two-week low, according to a Bloomberg Valuation index. The benchmark 10-year note yielded 1.76 percent. The index’s record low was 1.63 percent in July.

The demand for lower-rated tax-exempts has benefited borrowers such as Temple University Health System. Philadelphia Hospitals & Higher Education Facilities Authority sold $311 million of hospital revenue bonds on behalf of Temple in June. The securities have a Ba1 Moody’s rating.

Buyers have been willing to accept a shrinking amount of additional yield on the debt.

Securities due in 30 years traded Aug. 21 with an average yield of 4.7 percent, or 1.59 percentage points above a benchmark index, data compiled by Bloomberg show. When the bonds were issued, they priced to yield of 5.875 percent, or about 2.75 percentage points above the index.

More Room

Riskier muni debt may still have more room to rally. The extra yield on munis due in 30 years and rated BBB, two steps above junk, was about 1.86 percentage points over top-rated securities yesterday, almost 33 percent more than the 10-year average, Bloomberg data show.

The “muddling” pace of U.S. economic growth will depress interest rates and foster demand for more income through next year, said Tim Pynchon, who helps manage $3 billion of high- yield munis at Pioneer Investment Management Inc. in Boston. The economy expanded at a 1.7 percent annual rate from April through June, after a 2 percent gain in the prior three months.

“There’s very little value left from a price appreciation standpoint in the investment-grade market,” Pynchon said. “We’ll still have some left in the high-yield market.”

Following are pending sales:

ILLINOIS FINANCE AUTHORITY is set to issue $181 million of revenue bonds on behalf of OSF Healthcare System as soon as tomorrow. The proceeds will refinance debt and support capital projects, according to bond documents. (Added Sept. 5)

SAN ANTONIO plans to sell $175 million on behalf of its water system as soon as tomorrow, according to offering documents. The proceeds will be used for construction and refunding. (Added Sept. 4)

To contact the reporter on this story: Michelle Kaske in New York at mkaske@bloomberg.net

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


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Companies Mentioned

  • HYMAX
    (Lord Abbett High Yield Municipal Bond Fund)
    • $11.65 USD
    • 0.01
    • 0.09%
  • ABTHX
    (AllianceBernstein High Income Municipal Portfolio)
    • $11.11 USD
    • 0.01
    • 0.09%
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