Feb. 4 (Bloomberg) -- Investor confidence in U.S. municipal debt is the highest since 2011, signaling more gains with local governments showing the fewest defaults since at least 2009 while revenue recovers to pre-recession levels.
It cost the annual equivalent of as little as $172,000 last week to protect $10 million of munis for 10 years through credit-default swaps, according to Markit Group Ltd. data compiled by Bloomberg. That’s the cheapest since July 2011. The price of swaps for California, which had its credit upgraded last week for the first time in six years after forecasting a surplus, also set an 18-month low.
The declining price shows investors in the $3.7 trillion muni market view three bankruptcy filings last year by California cities as isolated events running counter to the trend of improving state finances. Defaults fell the past two years, as the jump forecast in 2010 by banking analyst Meredith Whitney, chief executive officer of Meredith Whitney Advisory Group, didn’t materialize.
“All of the fear has been wrung out of the market,” said Bart Mosley, co-president of Trident Municipal Research in New York. The declining credit-default swap price “reflects the extent to which we fully moved past the Meredith Whitney era in terms of scares about the market.”
While investors such as hedge funds are among the biggest users of the swaps, the contracts reflect sentiment across the broader market. Yields fell in December to the lowest since 1965, and munis last month outpaced Treasuries by the most in a year. Buyers added the most money in three years to muni mutual funds in 2012, and invested about $4 billion more this month, Lipper US Fund Flows data show.
The swaps are contracts in which an investor or bank pays a fee for protection against a missed debt payment. The Markit MCDX index consists of 50 contracts of muni issuers, excluding tobacco and health-care.
The last time the cost was this low, munis were starting a three-month rally, the longest since the same period a year earlier. The contracts have dropped in price amid signs the U.S. economy is strengthening, Mosley said.
U.S. hiring gained in January after accelerating more than previously estimated at the end of 2012, Labor Department figures showed last week, and the Dow Jones Industrial Average rose above 14,000 for the first time since 2007.
States have benefited from the recovery, with tax collections increasing last year to above pre-recession levels, according to the Nelson A. Rockefeller Institute of Government.
The cheaper contracts “reflect a bullish outlook on state and local credits,” said Vikram Rai, a fixed-income strategist at Citigroup Inc. in New York. “It’s in response to the economy, the improving housing market and higher state taxes.”
The price has dropped about 40 percent from November 2011, when Jefferson County, Alabama, filed the biggest U.S. municipal bankruptcy. It is also down almost a third from the start of that year, following Whitney’s December appearance on CBS Corp.’s “60 Minutes.”
The cost of protection jumped 14 percent in the three weeks after Whitney forecast “hundreds of billions of dollars” of defaults in 2011. The remarks by the analyst helped push investors to withdraw the most money in two decades from muni mutual funds.
Though widespread failures never occurred, munis defaulted in 2010 and 2011 at twice the rate of the previous 39 years, Moody’s Investors Service said last year in a study of bonds it rates. In 2012, however, only 93 issuers defaulted on $1.7 billion in debt, the least for both measures since at least 2009, based on data from Concord, Massachusetts-based Municipal Market Advisors.
Tax-exempt bonds returned 7.3 percent last year and 11.2 percent the year before, the biggest consecutive gains in a decade, Bank of America Merrill Lynch data show. The gain came even with the three California Chapter 9 filings and Jefferson County’s bankruptcy.
“People are becoming more comfortable with the idea that the municipal market is what we thought it was,” said Justin Formas, who follows default swaps as director of credit research in Chicago at Bernardi Securities Inc., which manages $900 million in munis. “It’s a place where defaults are low and payment of principal and interest is consistent.”
In trading last week, yields on benchmark munis due in 10 years rose the most since December, by about 0.16 percentage point to 1.83 percent, close to the 2013 high, Bloomberg Valuation data show.
Following is a pending sale:
SANTA CLARA COUNTY in California plans to sell $490 million of general-obligation bonds as soon as Feb. 7 via competitive sale, according to data compiled by Bloomberg. (Added Feb. 4)
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