Tax-exempt municipal bonds are heading for their worst quarterly performance in more than 16 years as yields soared amid a U.S. Treasury selloff and the looming expiration of Build America Bonds.
Municipal investments have lost 4.5 percent this quarter through Dec. 27, the poorest return since a 5.7 percent loss during the first three months of 1994, according to the
Bank of America Merrill Lynch Municipal Master index, which accounts for price changes and interest income. As an extension of the Build America Bond program grew less likely, 30-year tax-free yields climbed about 97 basis points to 4.73 percent from Sept. 30 through yesterday, according to a Bloomberg Valuation Index.
“The primary reason for back-up is because of uncertainty that has resulted from the BABs scenario,” said Evan Rourke, a portfolio manager with Boston-based Eaton Vance Corp., which has almost $10 billion under management. “That's created temporary supply-and-demand imbalances, and Treasury yields have risen.”
Yields on top-rated 10-year tax-exempts were 3.1 percent yesterday, up from 2.33 percent on Sept. 30, BVAL indexes show. The move compares with an increase of 97 basis points in 10-year U.S. Treasury yields for the same period. A basis point is 0.01 percentage point.
Borrowing Costs Rise
The 78 basis-point jump in AAA yields will mean higher borrowing costs next year for even the most financially secure borrowers.
Summit, New Jersey, which had its top ranking reaffirmed by the three major credit-rating firms, plans to issue $29 million along with its schools and sewer district to refinance existing debt, even as Governor Chris Christie slashed aid to municipalities to close a $10.7 billion budget gap. The city is located 28 miles (45 kilometers) west of Manhattan.
“The schools are no longer getting any state aid from Trenton, which has been a real blow,” said Thomas Getzendanner, a Republican councilman in the city, where 50 percent of the population voted for Christie in 2009. “We're having to fend for ourselves and make the necessary management adjustments for what taxpayers can afford,” he said in an interview.
The Build America Bond program, part of President Barack Obama's stimulus package, is set to end on Dec. 31 after Congress failed to extend it. Issuers across the U.S. moved up planned sales to this month to take advantage of the expiring subsidy, making the last three months of 2010 the biggest quarter for the securities since their April 2009 inception, according to data compiled by Bloomberg.
Worst on Record
The debt, which included a 35 percent federal subsidy on interest costs, has handed investors a 6.4 percent loss for the quarter, the worst on record, Merrill indexes show. The securities lost 5.8 percent in the final three months of 2009, the only other quarterly loss. Build Americas' popularity reduced tax-exempt issuance, and that trend is set to reverse next year, the Securities Industry and Financial Markets Association said in its annual municipal-issuance report Dec. 15.
“As people anticipated BABs not being extended, the market priced in some weakness” to longer-dated tax-exempt prices, said Chris Mier, chief municipal strategist with Loop Capital Markets LLC in Chicago, in an interview.
Treasuries lost 3 percent this quarter through Dec. 27, the worst three-month performance since a 3.1 percent loss in the second quarter of 2004, according to Merrill Lynch's U.S. Treasury Master index, which has returned 8.15 percent annually since its start in 1978.
“When Treasuries decline for three straight months, munis are going to get whacked as well,” Mier said.
Whitney Comments
Individual investors may also have been influenced by the adverse publicity munis have received, Mier said. So-called retail investors hold about 37 percent of the $2.86 trillion municipal market, according to
Federal Reserve data.
Meredith Whitney, the banking analyst and chief executive officer of Meredith Whitney Advisory Group, spoke Dec. 19 on CBS Corp.'s “60 Minutes” about the possibility of a “spate” of defaults among local municipalities triggered by states' fiscal stress.
For the year, munis are headed for a 2.3 percent return, the second-worst performance since 2000, according to Merrill's Muni Master index, which has averaged a 9 percent yearly return since 1989.
Many investors are also allocating cash to the stock market amid signs of an improving economy, Mier said.
The Standard & Poor's 500 Index has climbed more than 10 percent this quarter, touching a 1,259.90 yesterday, the highest since Sept. 8, 2008, Bloomberg data show.
--Bloomberg News--
