Despite 'Whoops,' investor favor for municipal bond issues remains
Give the customers what they want, the saying goes, and they will beat a path to your door. This seems to be the case with municipal bonds. For despite increasing sales volume, concern that lawmakers might try to stem the flow of new bond issues, and anxiety about possible future defaults in the wake of the bankruptcy of a public utility in Washington State, yields on municipal bonds have remained steady. According to a recent issue of Moody's Bond Survey, average municipal yields have fluctuated within a fairly narrow range of about half a percentage point since midyear.
At the same time, the Bond Survey reports, long-term financing through September reached $61 billion, up 24 percent over the same period last year.
While interest in municipal bonds ranges across the spectrum of investors to include individuals, commercial banks, and institutions, it is individuals who have grabbed up the lion's share. Through midyear, individuals held more that $ 170 billion in municipal issues, compared with $160 million for commercial banks.
A primary reason people buy municipal bonds, of course, is the tax-exempt yield from what is still one of the safest investments. And with the higher yields available now, municipal bonds have become attractive to people in more moderate income brackets. To match the return on a 9 percent municipal yield, for example, someone in the 30 percent bracket (about $30,000 on a joint return) would have to earn 12.86 percent on a taxable investment; if he is in the 40 percent bracket, the taxable yield must reach 15 percent.
Naturally, these high yields and the heavy sales they help generate have won the attention of tax collectors in and out of Washington. Already, people receiving social security benefits must include income from municipal bonds to determine if they are receiving enough annual income to have part of their benefits taxed.
Starting Dec. 31, Congress has banned the sale of mortgage subsidy bonds. These are used to raise money for low-cost mortgages for first-time home buyers. Congress is also debating a limit on the sale of industrial revenue bonds, used by cities and states to subsidize local industry.
In spite of - or more likely because of - these moves, cities and states have been issuing new bonds at an ever-increasing pace, giving investors many choices.
One example of possible opportunity in the face of adversity is in the same area as the Washington Public Power Supply System (WPPSS, or ''Whoops''), says Robert Ziegler, a vice-president at Advest, a brokerage. ''Obviously there's a resistance to go with nuclear power projects,'' he notes. But the WPPSS default has made it difficult for almost all municipalities in the Northwest - some quite sound financially - to sell bonds. As a result, they have to pay a high yield on AAA-rated bonds. Many of these, he adds, are insured by the Municipal Bond Insurance Association (MBIA), a private group underwritten by such firms as Fireman's Fund, Aetna, and The Travelers.
However, Peter Christus, an analyst with Gabriele, Hueglin & Cashman Inc., a New York bond trading firm, cautions that it was the Washington State Supreme Court that permitted utilities in the WPPSS consortium to escape financial responsibility for bonds sold to build five nuclear power plants, four of which were scrapped. It was this ruling that made possible the largest default in municipal bond history. As long as that precedent exists there, any bonds issued by the state or cities in Washington will have a ''stigma'' on them, he said.
It is for this reason he recommends that investors interested in municipal bonds join what is becoming a ''tremendous flight to quality.'' One way this can be done, he suggests, is through unit trusts of bonds. The trust is made up of a specific number of bonds. Unlike mutual funds, the portfolio does not change. As each bond matures, the proceeds are paid to the shareholders.
There are also straight municipal bond funds, which have greater flexibility for both the fund and the investor. It is easier for you to move money in and out of the fund, and the fund can change the bonds in its portfolio.
You can also help ensure safety by investing in bonds insured by the MBIA or one of the other major insurance groups. This increases the likelihood that someone will repay the principal, should the issuer run into difficulty.
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