U.S. municipal bonds are on course for their worst monthly returns in more than four years, but some experts think this may be a good time to buy.
Amid bond insurer troubles and fallout from the auction-rate market, the municipal bond sector is already the worst performer among U.S. debt assets this month and second from the bottom year-to-date, behind only high-yield corporate bonds, according to Merrill Lynch indexes.
The February negative total return of 3.13 percent is the worst since a 4.59-percent loss in July 2003.
To be sure, some analysts say continued weakness will create buying opportunities, especially if yields on high-quality bonds move to the psychologically important 5 percent level, luring back individual investors and stemming further decline.
Michael Cohn, chief investment strategist at Atlantis Asset Management sees munis as a good buy because of their yields.
“Only two times -- over the last 20 years -- have I seen muni bond yields that were equivalent or higher than Treasury yields,” Cohn says. Plus, he adds, you get double or triple the tax advantage. “It’s a tremendous bargain as far as I’m concerned.”
The average investor may be shying away from municipal bonds based on all the negative headlines. But Nadav Baum, managing director of investments at BPU Investment Management, says munis are a good deal right now.
“Absolutely, you always buy high-quality vehicles when nobody wants them,” Baum says. “When there are AAA-rated insured muni bonds that are trading at prices like A-rated hospital bonds, there’s a major opportunity for you to go up the scale of quality.”
Still, muni-bond holders are likely to face more losses in the coming months. And states, cities and towns may find it harder and more expensive to raise money just as their borrowing needs increase because revenues have slowed with the economy, portfolio managers and analysts said.
The $2.6 trillion market has been hit by selling from retail investors, money market funds and hedge funds, while buyers stay away and dealer support is dwindling.
Richard Marrone, portfolio manager at Evergreen Investments in Charlotte, North Carolina, said bond insurer troubles and the near collapse of the auction-rate market have to be resolved before the market could stabilize.
"It could be ugly into the summer," Marrone says.
Issuers such as Puerto Rico, Ohio and electric utilities in Chattanooga, Tennessee, and Georgia have already postponed deals rather than pay the high rates, as the yield on top-rated 30-year munis on Wednesday rose to a six month-high of 4.79 percent.
But without dealer support and with demand from hedge funds declining, the market may not absorb heavy primary supply that is expected to emerge as issuers raise new money and
restructure troubled auction-and variable-rate debt to avoid paying high interest rates.
JPMorgan Securities estimated that states and municipalities will sell $210 billion of debt this year, mostly fixed-rate, to exit the volatile floating rate markets, boosting overall issuance to what would be a record $460 billion.
Recent problems in the auction-rate market indicate that dealers may not be able to commit as much capital to the new issue market as before, said George Friedlander, municipal bond
analyst at Citigroup wrote in a report.
"The market is thinner, more volatile, and more reliant on individual investors than it had been," Friedlander says. "The Street's capacity to position surplus new issue supply until it can be sold over time is clearly impaired."
The subprime mortgage crisis has already cost investment banks $140 billion in write-downs and credit losses. And heavy selling of municipal debt in the wake of bond insurer troubles
has clogged up dealer inventories, leaving little room to add new risk.
"Dealers are full. Dealers have gotten hurt in here and they are just throwing up their hands, saying let this thing settle down before we get involved again," said Laura LaRosa, portfolio manager at Glenmede Trust Co. in Philadelphia.
More than $1 billion of bonds were put out for sale on Thursday, according to a trader in New York. Year-to-date the average daily bid-wanted volume was around $623 million, twice as much as last year and a five year high, said Matt Fabian, managing director at Municipal Market Advisors.
Hedge funds have been unwinding their leveraged trades, known as tender option bond programs, as funding costs have spiked due to disruptions in the variable-rate market.
"People who have been supporting the market are no longer supporting it," said a trader in New York. "The supply that is being created by these guys unwinding is like a shadow calendar. The market is still in the process of reacting to it."
Hedge fund selling can add $25 billion to the secondary market, Merrill Lynch estimated, further pressuring municipal bond prices.
"I don't see it stabilizing in the near future," LaRosa added.