Worst Losses Since 1999 Defy History’s Rally Signal: Muni Credit
The biggest losses since 1999 for municipal debt signal that Detroit’s bankruptcy and 14 weeks of withdrawals from mutual funds are overwhelming historical trends pointing to a rebound in the $3.7 trillion market.
Local debt lost 1.6 percent in August, the steepest drop for the month in 14 years, Bank of America Merrill Lynch data show. It marked just the second time in 25 years that the obligations fell in both July and August, a period in which the market usually rallies as investors get cash from coupon and principal payments while issuance dwindles. The bonds also tend to gain in September, advancing in 15 of the past 24 years.
Benchmark yields are the highest since 2011 and exceed those on Treasuries and AAA company debt by the most in at least 20 months, data compiled by Bloomberg show. In 2011 and 2012, munis rallied when valuations reached current levels. Yet this year’s outsized losses suggest a rebound may not materialize in coming months after Detroit’s Chapter 9 filing helped propel the longest span of withdrawals from muni funds in two years, said Chris Alwine, head of munis at Vanguard Group Inc.
“We don’t have expectations of a rapid snapback,” said Alwine, whose Valley Forge, Pennsylvania-based company oversees about $125 billion in munis. “The technical conditions and the cloud of Detroit are overwhelming” the market.
Local debt has joined broad fixed-income declines spurred by concern that the Federal Reserve will slow its bond buying amid an expanding U.S. economy. Munis have lost 5.8 percent in the past three months, compared with declines of 2.7 percent for corporate debt and 2 percent for Treasuries, Bank of America data show.
Individual investors, who own about 70 percent of local debt directly or through funds, tend to inflate the market’s gains or losses, Alwine said. They have pulled about $20 billion from muni mutual funds this year, including $9.5 billion since Detroit filed a record $18 billion U.S. municipal bankruptcy on July 18, Lipper US Fund Flows data show.
“Munis are more attractive than they’ve been for a period of time, but negative investor flows are preventing the market from seeing any significant rebound,” said Benjamin Thompson, chief executive officer in New York at Samson Capital Advisors, which oversees about $6 billion in local debt.
Detroit Emergency Manager Kevyn Orr’s proposed treatment of general-obligation bonds has brought scrutiny to such securities nationwide. He seeks to give holders of the debt, which is backed by the full faith and credit of the city, less than 20 cents on the dollar. The bonds traditionally have been viewed as among the safest in the market.
The longest-maturity munis have led the selloff. The interest rate on benchmark 30-year AAA debt is 4.77 percent, the highest since April 2011. That compares with about 4.5 percent on top-rated company debt, according to Moody’s Investors Service data, and 3.79 percent on similar-maturity Treasuries.
Tax-free local yields rarely exceed those on taxable counterparts. The 30-year tax-exempt yield equals 7.9 percent taxable for the highest earners, Bloomberg data show.
Since January 2009, investors have demanded an average extra yield of about 0.6 percentage point to own 30-year corporate debt rather than munis, Bloomberg and Moody’s data show. That relationship has reversed, with the yield spread on munis over company bonds the highest in more than four years.
“Valuations are tremendously attractive, especially when you look at the long end,” said Rick Taormina, head of munis at J.P. Morgan Asset Management, which oversees about $33 billion in local debt. “We’re at a point where we have low supply and tend to do pretty well. This year we just have not seen that.”
As in past years, issuance waned during the U.S. summer, dwindling to about $23 billion in July and $24 billion in August, the slowest consecutive months since January and February, Bloomberg data show.
Before this year, munis posted monthly declines in both July and August only in 1999, Bank of America data show. The bonds extended the slide into September and October that year, losing 0.7 percent and 2 percent, respectively.
“We expect higher volatility, which goes hand-in-hand with cheap valuations,” Alwine said. “Ultimately, that cheapness relative to other fixed-income assets should come out of the market, but that may take some time to be realized.”
Municipal issuers such as The Board of Regents of the Texas A&M University System are set to sell $1.5 billion in debt this week, the slowest since January.
They’re borrowing as yields on benchmark 10-year munis have climbed to about 3.1 percent, close to the highest since April 2011. The interest rate compares with 2.86 percent for similar-maturity Treasuries.
The ratio of the yields, a gauge of relative value, is about 108 percent, compared with an average of 93 percent since 2001.
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