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Treasuries Losing Appeal With Widest Yield Penalty: Muni Credit

For investors including Gary Pollack at Deutsche Bank AG, that’s a signal to favor munis over taxable securities such as Treasuries. Photographer: Brian Marcus/Bloomberg
For investors including Gary Pollack at Deutsche Bank AG, that’s a signal to favor munis over taxable securities such as Treasuries. Photographer: Brian Marcus/Bloomberg

May 22 (Bloomberg) -- U.S. local governments are borrowing the most since March, pushing municipal yields to the highest level of 2012 relative to Treasuries and giving an added incentive to buy tax-exempt bonds.

Issuers from New York City to San Francisco plan to sell about $10.3 billion this week, data compiled by Bloomberg show. The wave is causing the $3.7 trillion municipal market to trail U.S. government securities. As a result, 10-year tax-exempt yields rose to 108 percent of those on federal debt last week, the highest since Dec. 2.

For investors including Gary Pollack at Deutsche Bank AG, that’s a signal to favor munis over taxable securities such as Treasuries. He may buy 10-year tax-exempts as soon as this week, heading into a several-month period where muni coupon and redemption payments are poised to exceed new bond sales by a total of about $20 billion.

“Sometime in late June, July we’re going to have a very nice period for munis, so I would want to get my crossover trade in before that occurs,” said Pollack, who manages $12 billion as head of fixed-income trading at Deutsche’s private wealth unit in New York.

Buyers monitor the yield ratio as a measure of relative value, shifting resources between the two asset classes. Investors are willing to accept lower yields on local-government bonds because the interest they pay is typically exempt from state and federal taxes.

Beating Treasuries

Munis have outperformed Treasuries this year as eight straight quarters of rising state tax revenue and a decline in defaults have boosted investor confidence. Tax collections have eclipsed the peak hit before the 18-month recession that ended in June 2009, according to the Albany, New York-based Nelson A. Rockefeller Institute of Government.

Local-government bonds have earned 4.1 percent this year, beating Treasury gains of 1.3 percent, according to Bank of America Merrill Lynch indexes. Twenty-year general obligations yield 3.75 percent, after touching 3.6 percent in January, the lowest since 1967, according to a Bond Buyer index.

Last week, Treasuries led as concern that Europe’s debt crisis is worsening drove 10-year federal yields as low as 1.69 percent, within 0.01 percentage point of a record. Ten-year Treasury notes yielded 1.74 percent yesterday, compared with 1.84 percent on benchmark tax-exempts of a similar maturity.

Average Since 2001

Since 2001, yields on 10-year municipal bonds rated AAA have averaged 92 percent of those on Treasuries, data compiled by Bloomberg show. The ratio peaked at 195 percent in December 2008 during the financial crisis as investors piled into sovereign bonds for a haven.

“On a relative-value play, this is a good time to be looking at municipals,” Alan Schankel, a managing director at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview.

Interest rates on AAA 30-year municipals climbed to about 113 percent of Treasuries last week, the most since Feb. 1. The average is 103 percent going back to 2001.

Pollack said he anticipates buying municipals within the next month, before coupon and redemption payments rise and boost demand for tax-exempt debt.

Such payments will total $113 billion from June through August, outpacing new issuance by about $20 billion, according to Chris Mauro, head U.S. municipal strategist at RBC Capital Markets in New York.

Sales Jump

This week’s sales amount is a 30 percent increase from last week’s $7.9 billion, the biggest leap since the start of April.

The supply jump may boost ratios between tax-exempts and Treasuries even more, Peter Demirali, who manages $500 million of taxable municipal assets at Cumberland Advisors Inc. in Mendham Township, New Jersey, said in a telephone interview.

“Supply is always an issue of the municipal-bond market,” Demirali said. “And given the low nominal yield levels that we’re at, you could expect ratios to widen out in order to distribute the deals.”

For the muni market, the $10.39 billion sold in the period ending March 9 made the week the busiest of 2012, according to data compiled by Bloomberg.

Following are descriptions of coming sales:

SAN ANTONIO plans to sell $650 million of electric- and gas-system revenue bonds as soon as tomorrow. Proceeds will refund debt, according to offering documents. Bank of America will lead banks. Moody’s Investors Service rates the bonds Aa1, second-highest. (Added May 22)

MASSACHUSETTS is set to issue $350 million of general-obligation bonds as soon as today to help finance capital projects. The debt will price competitively. The longest maturity for the bonds is 2042, according to offering documents. Standard & Poor’s rates Massachusetts AA+, second-highest. (Updated May 22)

To contact the reporter on this story: Michelle Kaske in New York at

To contact the editor responsible for this story: Stephen Merelman at

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