Nuveen muni manager Miller is snapping up debt tied to land projects

Jan 27, 2013 @ 12:01 am

By Bloomberg News

John Miller at Nuveen Asset Management LLC, who beat all his U.S. municipal bond fund peers last year, is betting that a rebounding housing market will deliver the biggest gains again this year.

Mr. Miller, 45, buys “dirt bonds” — debt used to fund housing development infrastructure — for the $9 billion Nuveen High Yield Municipal Bond Fund (NHMRX), which earned 21.2% last year.

The gain beat all open-end, national muni funds that are at least three years old and geared toward institutional investors, data compiled by Bloomberg show.

The fund invests in securities rated BBB+, three steps above junk, and lower. It is betting on the riskiest part of the $3.7 trillion muni market: Land-secured debt accounts for almost half of the muni issues in default.

Mr. Miller is working against a backdrop of increasing signs of a housing recovery. Builders last year broke ground on the most houses since 2008 and home prices rose the most in more than two years.

“We are still buying areas that are benefiting from the improvement in real estate markets,” said Mr. Miller, who helps manage $86.5 billion in munis as co-head of fixed income. “So we're still buying tax-allocation and property-tax-backed issues.”

Investors sought riskier debt last year as a rally in the muni market drove yields on local borrowings to a 47-year low.

Munis earned 7.3% last year, Bank of America Merrill Lynch data show.

Pioneer High Income Municipal Fund (HIMYX), run by Tim Pynchon, was second behind Nuveen's portfolio, returning 21.1%. Lord Abbett High Yield Municipal Bond Fund (HYMFX), managed by Daniel Solender, placed third, gaining 18.1%.

For the Nuveen fund, last year followed a 2011 performance that failed to place it in the top 10 muni portfolios. Even so, its 11.6% 2011 return eclipsed the market's 11.2% advance.

Last year's gain was fueled by a 20% allocation to land-backed debt, Mr. Miller said.

Such bonds make up about 7.4% of the S&P Municipal Bond High Yield Index. The tax-exempt securities finance real estate projects, with the developer paying special assessments to repay the bonds.

The real estate market is showing signs of gaining momentum.

Builders started new homes at an annual rate of 954,000 last month, the highest since June 2008, according to Commerce Department data. Housing prices rose 4.3% in October, from the year-earlier period, the biggest advance since May 2010, according to the S&P/Case-Shiller Composite-20 City Home Price Index.

Nuveen's eighth-biggest holding, revenue bonds backed by USG Corp., the nation's largest distributor of drywall, earned about 27% over the past 12 months, based on trading levels and assuming no reinvestment yield, according to data compiled by Bloomberg.

The debt, which financed a solid-waste facility in Pennsylvania, is state-tax-exempt and subject to the alternative minimum tax at the federal level.

A Florida dirt bond offer that Nuveen held as of Dec. 31 gained 26.9% last year through Dec. 5, based on trading prices and assuming no reinvestment yield.

“We were able to take advantage of credit spread narrowing in the sectors that actually did the best,” Mr. Miller said.

RESTRUCTURING PHASE

Still, land-secured borrowings are riskier than most munis.

As of Jan. 16, bondholders weren't receiving principal and interest payments on about $11 billion in muni debt, from 385 defaults, according to Municipal Market Advisors.

Land-secured debt, including dirt bonds, account for 188 of those filings — the most by number.

Holders of dirt bonds will need to take a loss on these deals to restructure the debt, said Richard Lehmann, publisher of the Distressed Debt Securities Newsletter.

The segment's fiscal strains are evident in the Tampa, Fla., region, which has 50 community development projects in default, he said.

“How do you sell any lots in that area when you have 50 distressed properties that have excessive tax allocations on them and they're all trying to bid for a very finite number of new-home buyers?” Mr. Lehmann said.

Debt backed by tobacco settlement payments from cigarette makers, as well as airline bonds, health care securities and industrial-development borrowings, helped fuel gains last year, said Mr. Miller and Mr. Pynchon, 53, who helps manage $3 billion of munis at Pioneer Investment Management Inc.

Tobacco bonds earned about 32% tax-free last year, beating all classes of munis, according to Barclays PLC data.

The top five muni funds last year were high-yield portfolios. Such funds may outperform again this year as the extra yield that investors demand on lower-rated securities has more room to shrink, Mr. Pynchon said.

The yield spread on BBB munis due in 30 years over top-rated tax-exempts set a four-year low of 1.66 percentage points in October. Still, that gap is wider than the 10-year average of about 1.45 percentage points, Bloomberg data show.

“I think there's still some value left and there are enough inefficiencies in our market so that the savvy high-yield investor is going to be able to realize some good value,” Mr. Pynchon said.

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