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Some who chase muni bonds’ higher yields may take more risks than they think
boston.com - March 12, 2010 - By Margaret Collins
estors in search of better returns poured $7.8 billion into high-yield municipal bond funds last year, pushing assets to a two-year high. They may start experiencing losses as early as this year as default risks grow.
“People are starving for yield because rates are at [nearly] zero,’’ said Paul Tramontano, cochief executive of Constellation Wealth Advisors. “They’re taking more risk than they think.’’
Below-investment grade munis are typically issued by companies raising debt through a municipality for a project with a public interest, such as a hospital, nursing home, or sports stadium, said Eric Jacobson, at Morningstar Inc.
High-yield municipal bonds rated BB+ or lower by Standard & Poor’s or Ba1 by Moody’s Investors Service, one level below investment-grade debt, have returned about 31 percent in the last 12 months, compared with 11 percent for investment-grade municipal securities, according to the indexes from S&P/Investortools.
But state and local government tax revenues were down 6.7 percent as of September from a year earlier, marking the fourth consecutive quarter of decline, according to a December Census Bureau report. That may drive defaults higher this year and next, according to Moody’s. It also expects “somewhat higher rates of default’’ among bonds not rated and those below investment grade.
“While high-yield, tax-exempt funds may look like a great opportunity, people [had] better be very wary of getting in there now,’’ said Michael Janik, senior credit analyst at Virtus Investment Partners Inc. “They could be burned.’’
Rising taxes are also driving investors to munis, said Jim Rosenkoetter, at Talon Asset Management. That’s because the bonds are generally exempt from federal taxes as well as state and local levies for residents in most states where they’re issued.
High-yield muni bonds due in eight to 12 years were yielding an average of 6.63 percent last month, almost double the 3.42 percent on similar bonds in the broader tax-exempt market, according to Barclays Capital. The average dividend yield on a stock in the Standard & Poor’s 500 index was 1.98 percent on March 9; the average interest on a taxable money market fund was 0.02 percent March 2.
Investors buying lower-rated issues risk not receiving interest payments, losing their principal, or having to sell the securities at a discount, said Lynnette Kelly Hotchkiss, of the Municipal Securities Rulemaking Board.
The risk of municipal bond defaults in the future is “higher than it’s been in quite some time,’’ said Deutsche Bank’s Pollack, because of the unprecedented stress on state and local budgets.
But state and local governments can raise taxes and cut services to continue to pay the interest and principal on their debts, said Scott Cottier, of OppenheimerFunds Inc.
“The fear of defaults is over-baked in the muni market,’’ Cottier said.
Margaret Collins writes for Bloomberg News.
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