Municipal Bond Yields in the 6% Range Beckoning to Investors

Unusually high municipal bond yields are luring wealthy investors--and even some not-so-wealthy ones--into cashing out stock profits to lock in rates on the tax-exempt securities.

With long-term municipal bonds yielding in the 6% range, investors in the top state and federal tax brackets now can get annualized yields equivalent to 10% to 11% on fully taxable bonds.

By comparison, even at its current 27-month high, the yield on the benchmark 30-year Treasury bond is 6.44%. That Treasury yield is taxed at the federal level, though not at the state level.

“For people in the highest tax brackets looking for ways to diversify, this [munis] is a great way to do it,” said David MacEwen, senior vice president and portfolio manager for American Century Investments in Mountain View.

That can be particularly true in California, which has one of the highest state income tax rates. A California investor who owns a California muni bond or bond mutual fund pays neither federal nor state taxes on the interest earned.

Long Beach ophthalmologist Stuart Cole recently sold about 10% of his stock portfolio to buy top-rated, insured municipal bonds. Cole, a muni bond investor for more than 20 years, said he wanted to lock in both some stock profits--and the high tax-free rates.

“It’s the first time in my recollection that triple-A, insured munis have approached Treasuries” in yield, Cole said. “Muni yields are so tremendous right now . . . it’s extra yield without [extra] risk.”

Rates are high enough to attract even some investors in the 28% federal tax bracket, said Marilyn Cohen, president of Envision Capital Management in Los Angeles. Typically, taxpayers must be in the 31% bracket or higher for municipal bonds to offer tax-equivalent yields that are greater than comparable Treasuries.

The 28% federal tax bracket begins at taxable income of $43,851 for married couples filing jointly and $26,251 for singles.

Cohen said clients who have sold businesses recently have invested some of their profits in municipals to capture the relatively high tax-free returns. Other traders said Internet millionaires and people who have significant stock in their company are also using muni bonds for diversification.

Single A-rated municipals have typically yielded about 87% of Treasuries with similar maturities, and about 77% of comparable corporate bonds, MacEwen said. Right now, the same municipals are nearly matching Treasury yields and yielding more than 80% of comparable corporates, he said.

Higher-rated munis, like the kind Cole buys, yield less than their lower-rated brethren but are still attractive compared with other bonds, many analysts say.

Bond yields in general have surged this year as the Federal Reserve has pushed market interest rates higher. In addition, corporate bond yields spiked in recent months as companies rushed to issue bonds before year-end to avoid any Y2K-related problems. Some large investors sold municipals to buy corporates, driving up muni yields still further.

Since then, corporate yields have dropped somewhat, but municipal yields have remained unexpectedly high, MacEwen said.

“We’ve seen a lot of people ‘tax loss selling’ into this market,” he said. Institutional investors, in particular, are selling older, lower-yielding muni bonds that have tumbled in value in order to offset stock market gains.

How long these high rates will continue is unknown, bond traders said. In recent years, municipal yields have typically dropped in November and December as traders anticipate a rush of new investors at the beginning of the year, said George Friedlander, managing director for fixed-income strategies at Salomon Smith Barney.

That hasn’t happened so far this year, but Friedlander is guessing that lower rates will come after Jan. 1--assuming bargain-hunters rush in.

There is no guarantee that bond yields overall won’t keep rising, of course--especially if the Fed continues to tighten credit in the first quarter of 2000.

As long as market yields are rising, the market values of older bonds decline.

Buy-and-hold investors like Cole generally don’t worry about such fluctuations, because they plan to hold their individual bonds until maturity, when the face value of the bond is repaid in full.

But occasionally Cole buys municipal bond mutual funds as a way to gamble on the future direction of rates. This year, he guessed wrong, and suffered losses.

Bond mutual funds have no maturity date, and their portfolios can be constantly changing. Hence, their share values can decline if interest rates rise over a sustained period.

Recently, Cole sold his bond funds and bought more individual muni bonds. A silver lining is that he will be able to use his losses for tax purposes to offset some of his stock market gains.

Cole uses a broker to buy his municipal bonds, typically checking with several to make sure he gets the best price. Individuals typically need $20,000 to $25,000 to buy a single muni bond, which is why financial planners usually recommend small investors use mutual bond funds instead.

But for those with the money, Cohen says it has never been easier for investors to buy muni bonds without a full-service broker, using DLJ Direct, E-Trade and other on-line brokerages.

She advises investors to stick with investment-grade bonds (those rated BBB or above).

Those wanting an extra margin of safety should look for bonds that are privately insured, experts say.

For investors interested in conventional (open-end) California muni bond mutual funds, those recently highly rated by fund-tracker Morningstar include California funds offered by such firms as Alliance Capital (phone: [800] 247-4154), Franklin Templeton ([800] 342-5236) and Vanguard Group ([800] 662-7447).

Liz Pulliam can be reached by e-mail at liz.pulliam@latimes.com.

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Tax-Free Yields Hit 3-Year Highs

Yields on tax-free municipal bonds have risen with other market interest rates this year, and in some cases have touched three-year highs. Here is the yield on the Bond Buyer index of 20 general obligation bonds. Quarterly closes and latest:

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Monday:

5.96%

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Source: Bloomberg News