http://www.businessweek.com/news/2012-11-26/biggest-taxable-rally-since-94-narrows-company-gap-muni-credit

Bloomberg News

Biggest Taxable Rally Since ’94 Narrows Company Gap: Muni Credit

November 26, 2012

Municipalities from Wisconsin to Connecticut are paying the smallest yield penalty in three years on taxable borrowings as investors seek out securities with higher interest rates and lower defaults than corporate debt.

With buyers looking to increase their income as Federal Reserve Chairman Ben S. Bernanke pledges to keep the central bank’s key overnight rate near zero through mid-2015, the extra interest rate paid by localities over companies has collapsed by about 76 percent this year, the most since at least 1994, data compiled by Bloomberg show.

The rally gave Wisconsin an opportunity to accelerate a $252 million taxable deal originally planned for 2013. The state, where Republican Governor Scott Walker has moved to limit collective bargaining rights for public employees, sold revenue bonds yielding about 0.8 percentage point less than a 2010 issue of federally subsidized Build America Bonds backed by a general- obligation pledge.

“The way the taxable muni market was and where interest rates have been, we decided to move and get the transaction completed before something happens beyond our control that would impact the market,” David Erdman, the state’s assistant capital finance director, said in a telephone interview.

Yield Demand

Investors typically seek more yield from states and cities than from corporations because local bonds trade less frequently and feature annual financial disclosure instead of quarterly reports. The rally in taxable debt has helped issuers finance pension-fund gaps and other projects not eligible for tax-exempt borrowing.

Yields on 30-year taxable munis rated AA, Standard & Poor’s third-highest grade, were 0.82 percentage point above an index of company bonds with similar maturity and rating, the smallest difference since July 2009, according to Bloomberg data. The gap has plunged from 3.35 percentage points Jan. 3.

Wisconsin’s sale shows the rally’s impact. A portion of the deal maturing in 16 years and rated AA-, S&P’s fourth-highest grade, priced Nov. 5 with a yield of 3.77 percent. That compares with the level of about 4.6 percent the state received in 2010 on taxable general obligations due in 16 years and rated one level higher at AA.

GE Comparison

The yields still have appeal relative to corporate debt. A segment of Wisconsin’s sale due in 2030 priced with a yield of 3.94 percent. About a month earlier, the finance unit of General Electric Co., the world’s largest maker of jet engines, sold a bond due the same year to yield 3.6 percent.

Investors buying taxable munis also benefit from historically lower default rates than on company debt.

From 1970 to 2011, an average of 0.08 percent of investment-grade munis that were sold a decade or more earlier defaulted, compared with 2.61 percent for investment-grade company bonds, according to Moody’s Investors Service.

Taxable munis have earned about 10.7 percent this year, beating the broader tax-exempt market’s 8.5 percent gain and 9.9 percent earnings for corporate bonds, according to Bank of America Merrill Lynch data.

Muni yields have fallen for four straight weeks, the best streak since July. The interest rate on benchmark 10-year maturities was about 1.45 percent, close to the lowest since at least January 2009, when the Bloomberg Valuation index data begin. Yields on a Bond Buyer index fell to the lowest since June 1965.

Smaller Share

Taxable local issuance is decreasing, helping fuel gains in the securities.

States and localities have sold $31 billion of taxable securities this year, or about 9 percent of all issuance, according to John Hallacy, muni research head at Bank of America in New York. That’s down from 35 percent in 2010, the final year of the taxable Build America Bonds program, created as part of President Barack Obama’s 2009 stimulus plan.

Issuers sold $188 billion of those securities, which give localities a 35 percent subsidy on interest costs.

Barring the revival of Build America Bonds, investors such as Peter Hayes at BlackRock Inc. see no end in sight for the taxable muni rally.

“There’s still a real demand for high-quality, high- yielding assets, which taxable munis are,” said Hayes, head of muni debt at New York-based BlackRock Inc., which oversees about $105 billion of munis.

Tax Adjustment

Reinstating the program would boost the amount of taxable muni issuance and push up yields, said Gary Pollack, who manages $12 billion as head of fixed-income trading at Deutsche Bank AG’s private-wealth unit in New York.

Any move to trim the federal deficit by limiting munis’ tax exemption may also spur more taxable issuance, should any agreement involve limiting the types of issuers that can sell into the tax-free market.

Such a plan would cause some issuers to switch to taxable securities, Hayes said.

“It’s going to be very difficult for them to really get in and slice up the market enough, which sectors should issue taxable and which should issue tax-exempt, but I wouldn’t totally discount the possibility,” Hayes said.

Following are pending municipal-bond sales:

NORTH CAROLINA MUNICIPAL POWER AGENCY NUMBER 1 is set to sell about $616 million of debt, including $81 million of taxable bonds, as soon as this week, data compiled by Bloomberg show. Proceeds will refund debt and finance improvements to a nuclear power plant, according to bond documents. (Added Nov. 26)

COOK COUNTY, ILLINOIS, plans to issue $330 million of general-obligation debt as soon as this week to refinance debt, data compiled by Bloomberg show. (Added Nov. 26)

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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