Biggest Exodus Since Whitney Ignores May Win Streak: Muni Credit
Individual investors fleeing the $3.7 trillion U.S. municipal-bond market at the fastest rate since 2011 are doing so at their own peril. Local debt has logged gains for five straight years in the month of May.
Muni mutual funds have lost assets for nine consecutive weeks, as individuals pulled out $2.5 billion, Lipper US Fund Flows data show. That’s the longest stretch since mid-2011, when investors withdrew $26 billion over 24 straight weeks following a December 2010 projection by banking analyst Meredith Whitney that local-government defaults would tally “hundreds of billions of dollars” within a year.
Local debt is still set to gain in May for the sixth straight year, according to Thomas McLoughlin at UBS Wealth Management and Justin Hoogendoorn at BMO Capital Markets. Investors will get back 21 percent more cash this month from maturing debt than in April, according to Citigroup Inc. At the same time, issuance is poised to drop to the least in a month.
“We have crossover buyers, modest supply and reinvestment cash,” said Hoogendoorn, a managing director at BMO in Chicago. “We could get much better performance in the muni market, in spite of the fact that it’s already done pretty well.”
The municipal market has gained 1.1 percent on average in May since 2008, Bank of America Merrill Lynch data show. Yields on benchmark 10-year munis have already dropped for seven consecutive weeks, the longest span since 2009, data compiled by Bloomberg show.
With interest rates near generational lows, about 60 percent of debt sales this year have refinanced higher-cost securities, Bank of America data show. That’s close to the 62 percent pace in 2012, which was the fastest in two decades.
The refunding trend has created an environment where sales of new state and city debt trail the amount of money investors receive from bond calls and coupon and principal payments.
Investors will get about $9.1 billion back from maturing securities this month, up from $7.5 billion in April, Citigroup data show. In June, the cash wave will grow to $17 billion, the most this year. Including refunding, bond calls and redemptions will exceed supply by $8.4 billion through the next three months, the data show.
Led by Illinois’s $300 million offer of sales-tax bonds, states and cities are scheduled to sell about $4.4 billion of long-term debt this week, the least since March, data compiled by Bloomberg show.
“We’re still in this tremendous bond-call experience throughout the marketplace, and that just adds to cash on hand,” said John Miller, co-head of fixed income in Chicago at Nuveen Asset Management, which oversees about $95 billion in munis.
Localities have sold about $113 billion this year through April 26, up from $108 billion in the same period of 2012, Bloomberg data show. They’ve scheduled $8.4 billion of debt sales over the next 30 days, the smallest wave since April 1, data compiled by Bloomberg show.
“New-issue volume is moderate and manageable,” which along with maturities and refunding calls creates a favorable environment for munis, Alan Schankel, head of fixed-income research in Philadelphia at Janney Montgomery Scott, wrote in a report last week.
UBS Wealth analysts led by McLoughlin, the firm’s New York-based head of muni research, said in a report last month that they “suspect a summer rally in munis may recur in 2013.”
The gains may hinge on demand from individuals, who own about 70 percent of U.S. local debt.
The 2010 comments by Whitney, chief executive officer of Meredith Whitney Advisory Group in New York, prompted the worst January losses since 1990 as investors yanked money from muni funds. Her forecast never materialized, with just $6.5 billion in muni defaults in 2011, data from Concord, Massachusetts-based Municipal Market Advisors show. Last year’s total fell to $1.8 billion, the lowest since at least 2009.
In a Bloomberg TV interview last week, Whitney warned of a “negative feedback loop from hell,” in which financially strained states such as California that try to raise taxes to balance budgets lose companies and individuals to other regions.
“People are paying more via taxes and getting less, so people are voting with their feet,” she said, citing companies relocating to Texas from California. “It’s a very difficult cycle to break.”
Whitney isn’t alone in focusing on threats to the local-debt market.
Dan Gallagher, commissioner of the U.S. Securities & Exchange Commission, said at a roundtable in Washington last month that municipal bondholders may face financial “Armageddon” partly because of rising interest rates.
Ten-year Treasury yields (BVMB10Y) will climb about 0.5 percentage point to 2.25 percent by year-end, according to the median forecast of 67 analysts in a Bloomberg survey. The securities fell in price May 3, with yields touching a three-week high, after a report showed U.S. employers added more jobs in April than forecast.
At 1.73 percent, yields on benchmark 10-year munis are below those on comparable-maturity federal debt for just the second time since March 12. The yield ratio of the two securities, a gauge of relative value, is about 99 percent, down from as high as 113 percent last month.
Muni yields eclipsing those on Treasuries spurred demand for tax-exempt bonds from buyers who typically focus on other fixed-income assets, such as mortgages, BMO’s Hoogendoorn said.
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