Tax-Rate Boost Sustains Longest Rally in Five Years: Muni Credit
Income-tax increases for the wealthiest Americans are poised to sustain the longest municipal-bond rally in five years, even as U.S. localities are set to sell the most debt since 2010.
States and cities will issue as much as $386 billion in 2013, according to the average of estimates from Citigroup Inc., Janney Montgomery Scott LLC, JPMorgan Chase & Co., Morgan Stanley and RBC Capital Markets LLC. That would be up from about $352 billion in 2012 and the most since the Build America Bonds program expired two years ago, data compiled by Bloomberg show.
About 77 percent of U.S. households face higher levies after Congress this week ended a payroll tax cut, according to the nonpartisan Tax Policy Center in Washington. In a Jan. 1 accord to avert most of the $600 billion of tax increases and spending cuts slated to begin this month, lawmakers also boosted income-tax rates on households earning $450,000 or more to 39.6 percent, from 35 percent.
“That’s positive for municipals because it makes the tax exemption more attractive,” said Alan Schankel, managing director of fixed-income research at Janney in Philadelphia.
Investors betting tax rates would rise as part of steps to curb the federal deficit pushed yields on 20-year general obligations to a 47-year low of 3.27 percent last month, according to a Bond Buyer index.
Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management Co., included “high-quality” munis in his December list of picks. He has directed 5 percent of his $285 billion fund to munis for three straight months. It’s the longest stretch where local borrowings have been that high a percentage since at least 2006.
The $3.7 trillion muni market earned 7.3 percent in 2012, compared with 2.2 percent for Treasuries, according to Bank of America Merrill Lynch data. Another positive return from tax- exempts in 2013 would mark the fifth straight year they delivered gains, the longest stretch since 2007.
As prices on fixed-income assets fell yesterday after the deal in Congress, yields on benchmark tax-frees due in 10 years climbed to 1.83 percent, the highest since August, data compiled by Bloomberg show. For investors in the 39.6 percent tax bracket, the equivalent taxable yield is 3.03 percent. Treasuries of that maturity yielded 1.84 percent yesterday.
States and cities may sell as much as $415 billion of debt this year, Michael Zezas, a muni strategist at Morgan Stanley in New York, wrote in a Dec. 4 report. George Friedlander, senior muni strategist at Citigroup, anticipates about $400 billion of deals. JPMorgan expects $390 billion, analyst Peter DeGroot wrote in a November report. Janney expects localities will sell about $400 billion.
Chris Mauro, head muni strategist at RBC Capital in New York, has a smaller issuance projection of $325 billion. Localities have already taken advantage of opportunities to retire debt sold under higher interest rates, he said. Those deals included refinancings where proceeds sit in escrow until the original bonds can be repaid -- so-called advance refundings.
“A lot of issues that would be eligible for current refunding in 2013 have in fact been already taken out by advance refunding deals in 2012,” he said.
The debate on munis’ tax exemption may cause his issuance projection to fall short, he said.
President Barack Obama has proposed limiting the value of the muni tax break for higher earners to 28 percent.
Such a move might prompt municipalities to ramp up borrowing before any changes take effect, Mauro said.
For now, the higher income-tax rates are driving investors.
The largest exchange-traded fund tracking munis, the iShares S&P National AMT-Free Municipal Bond Fund (MUB), rose 1.1 percent yesterday to $111.80, the biggest gain since February.
Following is a pending sale:
OHIO plans to sell $219 million of general-obligation debt as soon as Jan. 8, data compiled by Bloomberg show. Proceeds will help finance capital projects and refund debt, according to bond documents. (Added Jan. 2)
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