Muni Bonds Seen as Attractive

Their tax-free yields are today close to those of taxable Treasury bonds

THE municipal-bond market - pummeled by the default of Orange County, Calif., last December - is finally edging back to life.

After a dearth of new issues from skittish jurisdictions around the United States early this year, scores of new bonds are again coming to market. Ratings have been generally high; there has been no new headline-grabbing Orange County-type default, which lost $1.7 billion in high-risk investments.

And the best news of all: "In relative terms, municipal bonds are very attractive right now," says Joe Mysak, editor of Grant's Municipal Bond Observer in New York.

With yields running between 6 percent and 7 percent last week, "muni" bonds are competitive with alternative fixed instruments, including United States government Treasury issues and corporate bonds. In fact, the spread between municipal bonds and Treasury issues has been at its lowest level since the October 1987 stock-market crash.

According to investment firm John Nuveen & Co., in Chicago, municipal bonds are now yielding 91 percent of 30-year Treasury bonds, a five-year high. (See chart.) That ratio had been as low as 80 percent just last summer. And in the summer of 1992, it was even lower, at 79 percent.

Add in the tax advantage of municipals, and the instruments look even better. Municipal bonds - issued by state and local government agencies to finance various types of civic projects - are usually not subject to federal taxes and, if issued in the state where you live, may also be exempt from state and local taxes.

Tempting yields

Last week, for example, the average yield for a muni bond on the Bond Buyer 40 index was 6.18 percent, compared with a yield of 6.85 percent for the 30-year Treasury bond. So, if you had $10,000 invested in a muni bond paying 6.18 percent, you would earn $618, compared with $685 from a 30-year Treasury bond.

But that is before federal taxes. The municipal bond is not subject to those taxes, but the Treasury bond is. This means that, if you are in the 28 percent tax bracket, the American government will take $191.80 of your earnings on the 30-year Treasury issue.

Clearly, many investors are rediscovering municipals, as illustrated by what's happening in the huge mutual-fund market.

Last year, flows into municipal-bond funds plummeted. Many investors, in fact, redeemed shares. At the start of 1994, investors had assets totaling $260 billion in 1,024 muni-bond funds tracked by the Investment Company Institute, an industry trade group in Washington.

But by the end of the year, after a large number of redemptions, assets had fallen to $227 billion. Now that downward spiral has stopped.

Muni-bond inflows were negative in January, March, and April of this year, but they were up substantially in February and May. Thus, by the end of May, assets in muni-bond funds stood at $246 billion. (Figures for June are expected this week.)

Still, many muni-bond funds have posted dismal earnings this year relative to other types of mutual funds, such as equity funds.

"There's been a fresh cash flow into municipals," says Paul Williams, vice president and manager of investment strategies for John Nuveen & Co. Nuveen manages over $30 billion in some 75 muni-bond funds.

Where is the new money being invested in municipals coming from? Some of it may be recycled old money. Municipal issues worth around $50 billion reached maturity in April and June. Some of that money, Mr. Williams says, might have been put back in new muni issues.

But some could also be coming from investors taking profits from the stock market, he says. Whether some investors pulling money out of the market last week will reinvest it in municipal bonds remains to be seen.

Sales decline

So far this year, about 4,800 new municipal-bond issues having a capitalization of around $72 billion have come to market.

That is under half the $162 billion value of new municipal issues last year. And the 1994 level was well below the new issues valued at $289 billion in 1993, according to Sharon Foight, a municipal-bond specialist with Securities Data Company, a financial-services firm in Newark, N.J.

If you are interested in purchasing a municipal issue, go to a broker or investment adviser such as a bank, or acquire shares in a mutual fund. Mutual-fund shares provide greater diversification than individual bond issues.

In purchasing a municipal bond, or muni-bond fund, Williams says, you need to ensure the credit quality of the bond issue. You also should determine whether your bond or bond fund provides tax-exempt status at the state and local level, as well as the federal level.

Regardless of the Orange County bankruptcy, municipal bonds have a default rate of only about 1 percent, Mr. Mysak says.

But investors need to carefully watch one potential threat to muni bonds, analysts say.

Congressional plans to scuttle the income tax with a "flat tax" could throw the muni market into confusion. Under current plans, interest on all bonds would be tax-exempt. That would mean that muni bonds would lose their main tax advantage against Treasury and corporate bonds, both of which are now subject to federal taxes.

But no congressional action is expected until after the 1996 presidential election. Moreover, some bond experts hold that muni bonds would retain their attractiveness, given their generally low default rate and high credit ratings.

You've read  of  free articles. Subscribe to continue.
QR Code to Muni Bonds Seen as Attractive
Read this article in
QR Code to Subscription page
Start your subscription today