No Relief Likely for Muni Bonds
By JEANNETTE NEUMANN And SERENA NG
With last week concluding the slowest quarter for municipal-bond issuance in 11 years, attention is shifting to when borrowers will come back.
If they ramp up soon, it won't be pretty, say bankers and portfolio managers, who say demand remains weak.
The outlook could bring dreary results to governments and other public borrowers hoping to tap the municipal market for construction projects. Pictured here, road construction in Rio Rancho, New Mexico.
."Even if [supply] were to pick up, I'd like for there to be demand, but personally I don't foresee it," says Michael Marz, vice chairman of First Southwest Co., a Dallas-based investment bank specializing in public finance.
That outlook could bring dreary results to holders or sellers of municipal bonds, as well as governments and other public borrowers hoping to tap the municipal market for construction projects and other finance needs. On the bright side, opportunistic investors seeking a high yield from borrowers are more likely to get what they want.
Lately, neither individual nor large investors in the U.S. municipal-bond market are showing much appetite for such bonds, which began to dive in late 2010 and, after regaining some ground, suffered more price pressure in March.
While the individual-investor exodus from municipal-bond mutual funds has eased, overall outflows had continued for 20 weeks in a row as of March 23, according to estimates from the Investment Company Institute, a trade group.
Net weekly outflows slowed to an estimated $569 million for the week ended March 23, the most recent data available from ICI, compared with an estimated $5.7 billion in the week ended Jan. 19. But Doug Gaylor, who manages about $3 billion in municipal assets for Principal Global Investors, says he doesn't think the streak of withdrawals will subside soon.
.Worried about more client withdrawals, Mr. Gaylor is keeping twice as much cash on hand as he typically had before the current mess. Municipal-bond investors remain rattled by governments' fiscal health, and some investors are selling to pay taxes. "The municipal market isn't in good shape," he says.
It doesn't help that some financial firms that typically are big buyers of municipal bonds are also retreating.
American International Group Inc.'s property-and-casualty insurance business has long invested a large portion of its U.S. insurance premiums in municipal bonds. But the insurer pared down those holdings in 2010 based on its view of the risk-return tradeoff and the U.S. unit's tax objectives, according to the insurer's annual report.
As of Dec. 31, AIG's units held $46.6 billion in municipal bonds, down 14% from $54.1 billion at the end of 2009. The bailed-out insurer has been shifting more money into taxable investments, partly because it now has less need for the tax benefits that municipal bonds provide.
Allstate Corp., which sells auto and home insurance to individuals across the U.S., has sold about $8 billion in municipal bonds since last year, decreasing its total municipal holdings by about a third to $16 billion, according to Tom Wilson, the company's chief executive. Allstate had 16% of its investment portfolio in municipal debt at the end of 2010, down from 21% a year earlier.
"If you don't like the income statement, the balance sheet, you're not crazy about management and they don't have good governance, why would you loan anybody money, other than the fact that they haven't defaulted in the past?" Mr. Wilson said in a recent interview. "That's not every municipality in the country, but it is some." As a result, Allstate decided that "we just weren't going to lend them money."
Some analysts and bankers say the municipal-bond world isn't as broken as skeptics claim. Demand by individual investors has remained relatively robust for bonds maturing in one to five years. Retail buyers have heightened their interest partly because of the potential for rising interest rates and concerns over the long-term liabilities of governments.
Municipal bonds are being helped by an influx of hedge funds, recently attracted to the sector by the higher yields on those securities. How long hedge funds will remain in the market is hard to tell, though, because they often barrel in and out of positions quickly.
The weak demand is showing up in sluggish trading of new and outstanding bonds. In the first quarter, the average daily trading volume of municipal bonds was $11.6 billion, down 15% from a year earlier, according to data from the industry's self-regulatory body.
"It will take days and maybe a week or longer to clear deals," says Marty Vogtsberger, head of capital markets at Fifth Third Bancorp's Fifth Third Securities municipal brokerage and underwriting unit, based in Cincinnati. "When demand was robust, you could pretty much get everything done during the order period," often one or two days for retail investors.
Given current conditions, some experts worry that even a minor increase in issuance could weigh further on prices, which move inversely to yields.
Yields for 10-year triple-A-rated government bonds were 3.21% on Friday, while those maturing in 30 years were 4.8%, according to Thomson Reuters Municipal Market Data. Those yields are down from the peaks reached in mid-January, but remain well above the 2.51% yield on 10-year bonds and the 3.86% yield on 30-year bonds on Nov. 1.
Supply projections vary. Municipal Market Advisors, a research firm in Concord, Mass., recently revised its projections for municipal-bond issuance this year downward to $200 billion. That would be a cliff dive from the $431 billion in municipal bonds issued in 2010 as local governments raced to lock in the benefit of an expiring federal subsidy.
"We had such a party in 2010, now we sort of have a hangover," says Noe Hinojosa, chief executive of Estrada, Hinojosa & Company, a municipal investment banking firm in Dallas.
—Michael Corkery contributed to this article.
Write to Jeannette Neumann at Jeannette.Neumann@wsj.com and Serena Ng at firstname.lastname@example.org