US: Credit Market

Big Names Are Hopping Into Munis, Should You?


You know an asset class looks inexpensive when non-traditional investors, namely the biggest U.S. value investors, start buying in. Such is the case with the battered U.S. municipal bond market.

Hundred Dollar
Bill Haber

In the last week Pimco chief Bill Gross, Loomis Sayles' vice chairman Dan Fuss, and billionaire Wilbur Ross, have been purchasing "munis" after a number of hedge funds and other players that use leverage have been forced to sell billions of dollars of bonds.

Munis, which experienced one of their worst monthly declines in February, have been beaten down to price levels that have produced juicy yields too hard to pass up even for investors not usually seen in the long-term tax-exempt bond market.

Muni Bond Mayhem

In fact, "AAA" rated 10-year municipal debt is yielding 6.0 percent more than 10-year U.S. Treasuries. At the start of the week, they were yielding 17 percent more than 10-year benchmark U.S. Treasury notes, and just Wednesday they were yielding about 10 percent more than 10-year Treasury notes.

Even more eye-popping: in the last 27 years or so, the average 10-year municipal debt paid out interest that was 20 percent less than the 10-year Treasury note.

There's an added sweetener for investors. The chief attraction to munis, of course, is that their interest is exempt from federal income taxes; if they're issued in the investor's home state, they're usually exempt from state and local income levies, too.

Small wonder, then, that buyers of all types abound.

"You have a yield disparity of huge proportions," said Dan Fuss, vice chairman of the investment company Loomis Sayles, which manages $100 billion of fixed-income assets. He co-manages the $17 billion Loomis Sayles Bond, a top-ranked taxable bond fund.

"I'm not sure how you can't call these bonds very good deals," added Andrew Feltus, portfolio manager at the Pioneer High Yield Fund and who oversees $11 billion in junk bonds at Pioneer. "These are rock-solid credits," Feltus said.

With the muni market's recent sell-off, owing to liquidity issues that are seen as temporary, the yields have become as attractive as corporate or junk bonds.

"Municipal bonds are trading at terms as attractive as what an investor can get in taxable credits," said Feltus.

Fuss of Loomis said he was able to purchase bonds backed by toll-road revenues at around 95 cents on the dollar. "You don't get much of this stuff because they hardly go on sale," Fuss said. "So when they do, you buy!"

Fuss, who has been purchasing munis at the start of the week, said he purchased more securities Thursday.

Bill Gross, who manages the $120 billion Pimco Total Return Fund, told Reuters that he had bought $1.5 billion of munis on Friday. He said Pimco was able to purchase them at "very attractive" prices, but declined to provide average levels and rates at which he received.

Thursday, Ross said he bought $1 billion of munis last Friday, too, because yields had risen to "relatively unparalleled" highs compared with taxable Treasuries.

The municipal bond market has been shaken by the global credit squeeze after an avalanche of selling took place by leveraged hedge funds attempting to meet margin calls.

Concurrently, some muni borrowers have seen interest rates soar because they sold so-called auction-rate securities with rates that regularly reset. Hundreds of auctions in the $330 billion market have "failed" since late January as buyers balked, forcing municipal borrowers to pay sharply higher rates.

These series of events helped send the Merrill Lynch Municipal Master Index into negative territory. In February alone, the index was down 4.89 percent, its worst monthly recording since the index's launch in December 1988. The previous record was negative 4.59 percent in July 2003.

"A lot of hedge funds were getting margin calls because of the dislocation in the muni market," Ross told Reuters by telephone, adding that his purchases included California munis that offered yields of around 5.50 percent.

Traditional muni analysts are hardly surprised by the crossover interest.

"When taxable guys start coming into your market, it's pretty attractive," said Tom Metzold, manager of the Eaton Vance National Municipals Fund and who oversees more than $8 billion in munis at Eaton. "The muni market is the most compelling value it's ever been."