Muni market turns cold
The credit crunch is taking a heavier toll on the municipal bond market, a favored sector for individual investors.
Yields on tax-free muni bonds surged Thursday for the 12th straight session as many buyers stayed away. That’s bad news for California, which plans to sell bonds next week to raise $1.75 billion for infrastructure projects.
The annualized yield on an index of 40 long-term muni issues nationwide tracked by the Bond Buyer newspaper jumped to 5.33% on Thursday, up from 5.20% on Wednesday and the highest since 2002. The yield has rocketed from 4.74% five weeks ago.
A Bloomberg News index of 20-year California general obligation bonds sported a yield of 5.16% on Thursday, up from 4.63% five weeks ago.
Bond yields rise as the market prices of the securities drop -- a sign that investors are balking at putting their money into the issues.
In many cases, muni yields are above what taxable U.S. Treasury issues pay, an unusual occurrence. A 30-year Treasury bond pays about 4.51%.
Yet “there are very few buyers out there now” for munis, said Bob Fields, an expert on the market at bond giant Pacific Investment Management Co. in Newport Beach.
The normally low-key muni market, where states, cities and other municipalities borrow to fund their operations, has suffered a series of punches since late last year that have left investors wary.
The first punch was financial trouble at major bond insurance firms, which guarantee about half the muni market nationwide. With those companies reeling from losses on mortgage-backed bonds they insured, some investors have wondered whether the insurance the firms provide on muni bonds could become worthless.
Wall Street has been waiting on a plan by big banks to bolster the finances of one leading insurer, Ambac Financial Group, but it isn’t clear whether a deal will be reached.
More recently, the muni market has been upended by turmoil in subsets of tax-free issues known as auction-rate bonds and variable-rate demand notes, two types of floating-rate securities that had been popular with yield-hungry investors.
With buyers now scarce, particularly for floating-rate issues guaranteed by struggling insurers, most of the weekly or monthly auctions used to reset yields on the securities are failing to attract enough new money. That leaves current investors stuck with them or causes the bonds to be dumped on banks -- and triggers higher, “penalty” interest rates for the issuers.
On Thursday the California Department of Water Resources had to pay an annualized 5.44% on $47 million of auction-rate securities that reset every 35 days, up from the previous rate of 4%, according to the state treasurer’s office.
Many muni bond analysts emphasize that the main problem facing the market is excess supply at a time when nervous investors are conserving cash. Supply and demand are “deeply out of balance” in the muni market nationwide, according to a recent report from Municipal Market Advisors, a Concord, Mass.-based research firm.
That’s a far different problem from that plaguing the market for mortgage-backed bonds, which has crumbled because a rising number of homeowners are delinquent.
In the muni market, the vast majority of issuers aren’t having trouble paying what they owe investors. Historically, very few muni issuers have defaulted on their bonds.
Still, default worries may grow as the economy weakens, some analysts caution. The result could be that investors demand even higher yields on muni bonds to compensate for a perceived increase in risk, said Jim Lynch, head of Lynch Municipal Bond Advisory in New York. “There should be no rush to buy here,” he said.
The city council of Vallejo, Calif., had planned to vote late Thursday on whether to file for bankruptcy protection because its employee-benefit costs are soaring even as tax revenue declines. The vote was put off after officials said they had reached a tentative deal with their major unions.
Even high-quality muni issuers that have no credit problems may pay more if they borrow soon, simply because of the heavy supply of bonds expected to hit the market.
Many issuers that have auction-rate bonds or variable-rate demand notes outstanding are planning to pay off those securities with cash raised from sales of plain-vanilla bonds. The state’s Department of Water Resources, for example, expects to refinance up to $1.8 billion of floating-rate debt because of the turmoil in the market. That could mean higher bills for power consumers over time, depending on the cost of the fixed-rate bonds.
In Sacramento, state Treasurer Bill Lockyer intends to proceed with next week’s planned sale of general obligation debt, said Paul Rosenstiel, head of public finance.
Although the state may have to pay higher yields on the bonds than it would like, “we have a need to get into the market because we have a lot of projects to build,” Rosenstiel said, noting the numerous infrastructure programs approved by voters in recent years.
“We have a schedule, and we’re probably going to stick with it,” he said.
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