Sell-Off Leads To Muni Mania

October 22, 2008

As investors unload shares and prices tumble, yields on muni bond funds soar to new heights.

 

Cities and states are struggling to raise short-term financing to cover everything from paying teachers to making lease payments on buildings.

Some signs of relief are starting to appear, however. Most notably, California was able to raise $5 billion by selling short-term notes to investors last week. That was about $1 billion more than expected for the cash-strapped state, which represents the largest municipal borrower of its kind in the country.

"We're seeing some relief in short-term credit markets now. But states and municipalities are still being forced to pay interest on their bond issues that is much higher than in normal conditions," said Jim Colby, senior municipal strategist for fixed-income at Van Eck Global.

For fund investors, that translates into yields being offered on muni bonds that in many cases are shattering previous highs. Even in those that haven't scaled such heights, muni bond funds are paying interest at higher rates than similar-termed taxable issues backed by the federal government.

"We've had significant downward (pricing) pressure in the past two months," said Colby. "This has been an extraordinary period of time in the muni marketplace."

At the beginning of October, investors could buy a triple-A-rated 10-year muni bond yielding 4.23%. Heading into trading on Wednesday, that was up to 4.76%.

And it's happening at all levels of credit and maturities. As of yesterday's close, three-year muni yields were up on the month some 24 basis points to 3.19%. Meanwhile, 30-year muni bond yields were averaging 5.70%, up some 41 basis points since Oct. 1.

Eyebrow-Raising Jumps 

In a market where movements in yields of 20 basis points in a month are few and far between, recent yield hikes are causing bond portfolio managers to take notice.

"This is definitely a good time for a muni investor to lock in some good yields," said J.D. Steinhilber, a Nashville, Tenn.-based advisor who manages portfolios for high net worth and institutional investors.

Prices have been driven down to a point where munis, with their tax-free income streams, are now yielding more than similar-termed taxable Treasuries.

For example, the iShares S&P National Municipal Bond (AMEX: MUB) had a 30-day yield of 4.44% through Tuesday. And the SPDR Lehman Municipal Bond ETF (AMEX: TFI) was running at 4.69%. An ETF with a similar termed-portfolio, the Lehman 7-10 Year Treasury Bond Fund Index (NYSEArca: IEF), was yielding 4.05%.

"When even the longer-term muni ETFs on the market like MUB and TFI are trading at attractive yields, you're seeing some real value in the market," said Steinhilber, noting that a muni yield of around 4.5% equates to about 7.5% on a taxable basis for those in upper-tax brackets.

While not as juicy in terms of income payments, Market Vectors Lehman AMT-Free Short Municipal ETF (AMEX: SMB) offers a less risky profile with 30-day yields of around 3.57% now. That represents up to a 5.49% tax-equivalent yield.

And its total return of -2.77% in the past three months is significantly better than longer-termed muni funds. Consider that SMB's sister Market Vectors Lehman AMT-Free Long Municipal (AMEX: MLN) has dropped about 14 percentage points more in the same period.

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