Will Tax Reform Kill Munis' Allure?Kelley Holland
Muni investors had reason to cheer at the beginning of 1995. There were widespread expectations that new muni offerings would be few and far between, and buyers raced into the market anticipating a scarcity that would drive up prices.
But things haven't worked out that way. In Washington, there has been serious talk of tax reform, which would erode the key tax advantages of munis. "Any substantial change is not going to be good for the value of an outstanding long-term muni bond," warns James J. Cooner, head of the tax-exempt bond management division of Bank of New York Co. And in California, acrimonious negotiations on restructuring the debt of bankrupt Orange County have cast a pall over that state's entire muni market. Munis, while rising in price along with all bonds, have performed worse than Treasuries.
THE BRIGHT SIDE. But there are still good reasons to consider munis. First, predictions of low muni issuance have come true--in spades. Muni underwriters all over Wall Street are crying in their beer over the paucity of new deals, and that's good news for Main Street. The Public Securities Assn. expects roughly $140 billion in new issues in 1995, less than half the $292 billion issued in 1993.
Moreover, munis currently offer excellent value relative to Treasury bonds. Muni yields are now close to 86% of Treasuries. That means that after adjusting for taxes, munis yield far more. "People will recognize the relative value in munis," says Richard J. Moynihan, head of the municipal-securities division at Dreyfus Corp. He sees muni prices rising so that yields fall to around 83% of Treasuries.
In fact, demand for munis is already picking up--even for California securities. One indication: Investors snapped up a $1.25 billion offering at the end of May by California's Foothills/Eastern Transportation Corridor Agency to finance new roads. "The oversubscription [for bonds] was extraordinary," says Paul C. Williams, head of investment strategies and research at John Nuveen & Co.
If the economy continues to slow, further declines in overall rates stand to help all muni buyers. Moynihan says investors could take extra advantage of falling rates by buying bonds trading at a premium. These bonds have coupons higher than those on new issues, so issuers might refund them if rates continue to fall. Such a move would boost the price of the high-coupon bonds.
With tax-reform proposals buffeting municipal bonds, the market is likely to remain unsettled throughout 1995. But at this time, the lures of munis are still greater than the pitfalls.
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