Single-A Municipal Debt Will Gain Amid Low Yields, Vanguard’s Alwine Says
Investors may move to A rated municipal bonds maturing in more than 10 years with top-grade rates near historic lows, said Chris Alwine, who oversees $125 billion as head of municipal funds at Vanguard Group Inc.
The yield on AAA rated 10-year tax-exempts fell below 2 percent on Dec. 9 for the first time since Bloomberg Fair Value data began in January 2009.
For today’s Bloomberg Brief: Municipal Market newsletter, Alwine also discussed public pensions, the tax-exempt status of municipal bonds and issuers that may struggle this year.
Q: Where are you looking for value in municipal bonds?
A: There are two pockets. The first is beyond 10 years in maturity. When the Fed did Operation Twist, we saw the curve flatten out to 10 years. From 10 to 25 years is the sweet spot, there’s value in there. We prefer to extend duration a bit to the 10- to 25-year area at this point.
The other pocket of value is in the A rated category. The credit conditions in our view are stabilizing.
People will find themselves there because there’s very little yield left in the market. They may not go down to below investment-grade or the non-rated space, but certainly we expect the A rated category to be a trend in 2012.
Q: Will issuers take advantage of low yields and sell more refunding bonds?
A: There is a large amount of debt that would make economic sense for issuers to refund, and we expect refunding volumes to pick up in 2012. We expect to have overall supply in the $325 billion to $350 billion range. Refunding could be upwards of 60 percent.
That’s not a net increase in supply though, because bonds are redeemed and the holders of those bonds will recycle that money into the new issuance.
Q: Do you expect interest rates to rise from historic lows?
A: We expect more of a range-bound market in terms of interest rates. If there was a crisis emanating from Europe, we would expect high-grade yields to go lower but credit spreads to widen. If there’s strong growth, we’d see rates rise and credit spreads tighten.
At these rate levels, there’s a large amount of the universe that’s refundable. So that’s something economical, and it will save the issuers money. Of course, if rates were to rise significantly, that would go away.
Q: Is there a particular issue or concern for the municipal market in 2012?
A: The issue that may be talked about more in 2012 is around pensions. That was in the news about 18 months ago and it was quieter in 2011.
We haven’t seen strong financial-market returns in the past year or so, and combined with the fact that many issuers are not funding to the actuarially required amount, that leaves the funding ratios at or lower than they were a year ago.
GASB is coming out with some new disclosure requirements around the discount rate. The impact of those changes will most likely show that plans have a lower funding ratio, and so we expect that to get some airplay in 2012.
Q: Are there any particular types of municipal bonds you’re concerned about?
A: The local GO area is where we’re most cautious. Based on the fiscal trends, it has a higher level of stress than you would have in essential-service revenues.
They have a higher reliance on property taxes, and the reassessment process is putting strains on the revenue front. At the same time the costs continue to go up. If you think of it as a household, costs go up every year, and if revenues aren’t keeping up, it causes financial stress.
Q: Will the tax-exempt status of municipal bonds be threatened in 2012?
A: We expect 2012 to be a rather light year for legislation coming out in Washington.
However, we believe that post-election, tax reform will be revisited and certainly munis will be on the table. It was brought up in the debt-ceiling debate as well as in the supercommittee, and it’s not an issue that goes away. But we don’t believe it’s a 2012 issue. 2013 or 2014 is likely when that will be revisited.
Q: Do you think credit quality will continue to drive investment decisions in 2012?
A: Absolutely. We’re in a slow-growth environment, and at the same time reserves have been drawn down a lot. The issuers, especially in the local GO area, have less of a financial cushion than they had a couple of years ago. Credit work is paramount in 2012 -- that won’t go away.
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