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MuniWatch: Investing Wisely in Municipal Bonds Today

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发表于 2009-10-23 19:51:17 | 显示全部楼层 |阅读模式
by Rob Williams, Director of Income Planning, Schwab Center for Financial Research
October 14, 2009

Key points:

  • Muni bonds continue to provide a useful balance of income and lowprincipal risk for higher-income investors, despite state and localbudget challenges.
  • Investor demand has soared, however, as investors seek higherafter-tax returns than cash, boosting prices and pushing down yields.
  • Our view on several large states and regions of particular interest to Schwab investors.
Late last year, we pointed to municipal bonds as an investingoption providing relative value for fixed income investors. A lot haschanged since then, but we still believe muni bonds will work for manyclients for their taxable accounts.

Here, we'll discuss the most pressing current issues of interest tomuni investors, including muni markets today, risk, how to consider taxadvantages and how to invest wisely.

Muni markets have rebounded
Since the end of last year, munis have enjoyed one of theirstrongest nine-month periods of the past 20 years. Paradoxically, thishas happened in the face of bad budget news across the country, a weakhousing market, and steep declines in both income and sales taxcollections.

There are two main reasons, in market terms:

  • Demand for municipal bonds evaporated last year, along with demandfor most other types of bonds besides US Treasuries. This pushed pricesdown, far past what was justified given realistic probabilities ofdefault on a well-balanced basket of individual bond holdings.
  • Demand has since rebounded.
The protection in munis drives demand
There's a bigger reason why muni bonds have recovered, though, that's likely to be more important to you—protection for investors in munis remain strong.The protection of principal isn't quite on par with Treasuries, but forthe highest-quality municipal bond issuers, it's close.

Despite the severe economic troubles, there have been noinvestment-grade defaults during the past year, and there were none inthe previous 30 years either. Defaults can occur, but they almost neverdo, for investment-grade bonds (i.e. rated BBB/Baa or above).

But let's broaden this discussion of risk: We're also talking about swings in price. This is especially concerning if you're not a buy-and-hold investor, or if you think seeing the value of bonds in your portfolio change might keep you up at night.

Most investors want to limit volatility, especially in bonds. And weall want to buy good values, to ensure we've tied in good yields today.

So, is now a good time to find that value, stability and the tax advantages in muni bonds? We believe that munis today are, for the most part, fairly valued. And there are ways to limit risk.

How to determine value in muni bonds?
One of the primary metrics helpful in evaluating the relative value ofmunicipal bonds compared to other bond investments are yields on abroad range of muni bonds compared to Treasuries.

Today, the difference in yields between a broad selection of thehighest-quality munis and Treasuries are back closer to normalhistorical levels—municipal bond yields in the 70% to 80% range ofequivalent Treasuries, as you can see in the chart below.

This means that for average investors, the highest-quality muni bondwill yield about as much as an equivalent Treasury after you factor inthe state and federal tax exemption. You might earn a touch more, ifyou're willing to take on a bit more credit risk.

Value compared to Treasury yields varies over time
Two-Year BondFive-Year Bond10-Year Bond30-Year Bond
Oct. 9, 2009Treasury Yield0.962.353.384.22
Muni Yield (AAA GO)0.781.762.994.45
Percentage of Treasury yield81%75%88%105%
March 30, 2009Treasury0.801.662.663.53
Muni0.992.093.484.91
Percentage of Treasury yield124%126%131%139%
Dec. 31, 2008Treasury0.761.552.212.68
Muni1.792.563.915.26
Percentage of Treasury yield234%165%177%197%
June 30, 2008Percentage of Treasury yield98%101%101%108%
Dec. 31, 2007Percentage of Treasury yield100%96%93%100%
Dec. 31, 2006Percentage of Treasury yield74%76%81%87%
Dec. 31, 2005Percentage of Treasury yield74%80%89%97%

Source: Bloomberg, as of October 9, 2009.

What does this mean to you?

  • First, compensation in the form of higher yields given thehistorical level of risk appears to be fairly valued today for mostinvestors. You might not find the screaming deals available late lastyear, but there are still valid reasons to invest.
  • You can search for individual munis using our bond search tools. See Take action at top right.
  • A great online source for free access to individual muniprospectuses (also called "Official Statements") and other informationis available at the Electronic Municipal Market Access website.Use it to look up information on individual bond investments. Third,all of this analysis will depend, of course, on your own tax rate. Ifyou pay no taxes (to take an extreme example), or you're invested in atax-exempt account, munis probably aren’t right for you. The pre-taxyields are often (but not always) lower than comparable Treasury bonds.
To determine your equivalent, after-tax yield, you would dividethe muni yield by the difference between one and your combined federaland (if applicable) state income tax rates. For example, a taxpayer ina 35% combined bracket would need a taxable bond yield of 6.15% just tobreak even with a 4% muni yield on an after-tax basis [0.04 ÷ (1 –0.35) = 0.06154]. Use your tax-equivalent yield to compare to taxablebond investments, as in the table below.

Calculate tax-equivalent yield to compare value compared to taxable bonds
28% rate28% rate
+ 5% state tax
33% rate33% rate
+ 5% state tax
To calculate:yield  divided by
(1 - 0.28)
yield  divided by
(1 - 0.33)
yield  divided by
(1 - .033)
yield  divided by
(1 - 0.38)
Muni yield3.00%3.00%3.00%3.00%
Tax-equivalent yield4.17%4.48%4.48%4.84%

Source: Bloomberg, as of October 9, 2009

How to invest?
If your goal is primarily to preserve capital and earn a bit ofadditional tax-exempt return above money market fund or Treasuries, stick with the highest-rated muni issuers. These issuers have the most ability to absorb economic and financial stresses, and are generally rated AA-/Aa3 or higher.

If you're aiming for slightly higher income, you might consider investing a portion of your portfolio in munis with slightly lower ratings—betweenA-/A3 and A+/A1—or slightly longer maturities. Limit your exposure hereto 30% or less of your muni portfolio, due to the potential for morevolatility in these issuers if weak economic conditions continue.

Right now, we see the best trade-off between yield and interest rate risk in short- to intermediate term maturities (orfour to eight years, or so, for the average maturity in your aportfolio or bond ladder) for investors with more than a short-termhorizon.

These maturities carry less risk that they'll lose their value thanlonger-term bonds if interest rates start to climb. The little bit ofextra yield in longer maturities may not be worth the risks, especiallyif you're worried about inflation (and rising rates) down the road.

Of course, you can also get exposure to all of these through a well-selected short- or intermediate-term municipal bond fund.

What are the risks?
Budget deficits and collapsing revenues, along with rising fundingcosts, might trigger a crisis mode for some state and local governmentsfor the foreseeable future, if not years to come. The impact of fallingproperty taxes, for example, can be felt for years, and can be slow torecover even as economic conditions improve.

But highly rated issuers have many protections and guarantees in placeto ensure that bonds are paid, even as local budgets are cut.

Even at the height of the recent budget crisis in states likeCalifornia, bonds continued to be paid. There was no discussion ofdefault, even as IOUs were issued and expenditures cut. As lawmakersbattled, many California general obligation (GO) bonds actually rose in price.

If you protect yourself with diversification, these issues may not matter much to your portfolio.These days, diversification is cheap and easy to find. Try to limitunnecessary exposure—say no more than 10% of your total fixed incomeportfolio—to any single issuer or security.

Here are some specific observations on a few of the nation's largestmuni issuers, for investors in particular states or regions:

New York City (AA/Aa2)
New York City is one of the nation's largest and most sophisticatedmuni issuers, and went through its own near meltdown during the 1970swhen it nearly filed for bankruptcy—but still never defaulted on itsbonds. These days, the picture is rosier, despite a dramatic drop inincome tax revenues.

Sophisticated budgeting practices and the ability to respond to revenueshortfalls quickly and decisively have supported strong bond ratings.The city is also a participant in New York Port Authority bonds andother bonds secured by dedicated sales and income taxes. Collapsingrevenues aren't good news, but there are many cushions in place.

New York State (AA/Aa3)
Like NYC, New York State confronts budget challenges. Like the city,analysts point to pro-active cost-cutting (politics notwithstanding) tomatch falling income sources.

The state also sponsors a Housing Finance Agency, Dormitory Authority,Thruway Authority and other dedicated finance authorities. Some of thestate-related authority bonds carry stronger credit protections thanstate GO bonds themselves, according to rating agencies, due to special"carve-outs" of revenues and protections.

New Jersey (AA/Aa3 negative outlook)
New Jersey residents pay some of the highest property taxes in thecountry. However, the impact thus far of the housing bubble has beenlimited compared to states with more speculative development such asFlorida and other sun-belt states.

Still, most states rely more on sales and income taxes than propertytaxes. Of the 50 states, 41 have income taxes as their leading revenuesource. While income taxes often drop sharply, they also tend torecover more quickly than "slower" revenues like property taxes.

This is one reason not to be as shocked by budgetvolatility in states like New Jersey, or others nationwide. If theeconomy recovers, states tend to recover more quickly. If they don't,they must cut spending before impacting long-term bond obligations. Theratings and credit quality of the state of New Jersey (and most others)are boosted by that pattern, but can and do change.

The rating outlook for New Jersey, for example, was placed on"negative" outlook by Moody's in August because "of a sizablestructural imbalance" in its budget resolved with "one-time" solutions.In other words, the state is biding time while it waits for revenues torebound.

Illinois (AA- negative/A1 negative outlook)
Recent budget troubles in Illinois illustrate the importance of willingness, as well as ability tokeep credit strong. State and local governments generally have thetools they need to keep budgets balanced, but they may not always havethe will—they have to deal with politics.

As a result of problems on that front, the state's ratings wererecently downgraded. Is there risk of default? Not likely. But aninability (or lack of commitment) to make tough decisions has decreasedthe margin for error and increased the possibility of additionaldowngrades.

California (A/Baa1)
An issue we've continued to follow is the state's cash position, whichwas strengthened last week by the successful sale of $8.8 billion innew revenue anticipation notes (RANs).

We expect to see additional headlines as the budget cycle begins againearly next year, unless we see a miraculous rebound in state income andsales tax receipts. But the question remains: Does it matter for munibond investors, given the credit protections?
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发表于 2009-10-23 20:49:31 | 显示全部楼层
I though muni are for rich people, because federal tax exemption. Other than that, there is not much advantage over US debt.
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 楼主| 发表于 2009-10-23 21:08:17 | 显示全部楼层
Linwood: I though muni are for rich people, because federal tax exemption. Other than that, there is not much advantage over US debt.
Well, it depends. NJ is much more experienced than me at fixed income.
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发表于 2009-10-23 23:32:15 | 显示全部楼层
nj89: Good info, 尽管有某种嫌疑.
You can calculate after-tax yield to see if it is better for you comparing taxable US debt. Right now, the yields of
这东西也跟CD一样,可以存不同期限吗?
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发表于 2009-10-23 23:41:24 | 显示全部楼层
nj89: 你可以买不同期限的muni mutual funds, 还是很liquid, 随时都可以卖. 当然如果利息高了, 价值就低了, 这是主要的风险.
谢谢NJ!现在总算知道一点儿了。
前几天FINANCIAL PLANER建议买这个,我连听说都没听说过。等有时间好好读读娘子贴的这篇介绍。
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 楼主| 发表于 2009-10-23 23:50:00 | 显示全部楼层
mist: 谢谢NJ!现在总算知道一点儿了。
前几天FINANCIAL PLANER建议买这个,我连听说都没听说过。等有时间好好读读娘子贴的这篇介绍。
我有红包
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发表于 2009-10-23 23:56:57 | 显示全部楼层
红娘子: 我有红包
谢谢娘子,拿到了!
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