Muni Update
    by Randy Jacobus
    Tuesday, August 6, 2013
    ASA believes that long duration municipal yields have reached levels that look historically attractive to investors and that relative to Treasury yields look attractive to hedged investors or cross over buyers. In addition, credits are generally improving with increasing tax receipts, supply is very supportive of lower municipal yields, and Federal/State tax rates are high. 


    1) Negative Fund flows are leading to cheaper long duration yields and a steeper curve.
    Open End Funds, Life Insurance Companies, Banks and Broker Dealers have been significant buyers of long duration muni assets. The recent bout of Fund redemptions have increased long duration yields and steepened the municipal curve.

     




    2) Where are high quality 30yr Municipal yields and are they attractive?
    The graph below shows the yields of 30yr AA rated NY Water bonds (blue) and 30yr Treasuries in green. Please note that only during the Lehman and Meredith Whitney credit scares were yields over 5%; even with Treasury yields substantially higher.



    3) Are Municipal yields cheap relative to taxable (Treasury) yields?
    Retail owns approximately 65% of the municipal market. The remaining 35% are owned by institutions, including insurance companies and banks.  These institutions often gauge their muni investments based on their relative value to taxable fixed income markets. The graph below shows the ratio between Municipal yields and Treasury yields.

     
      
    4) Supply
    The amount of reinvestment proceeds created by maturing bonds and coupons is large.  At some point it will be reinvested in Municipal Bonds.
                   


    5) Detroit Bankruptcy market ramifications?
     
    Although the Detroit bankruptcy is no surprise, there are two important takeaways:
    1.  The Bankruptcy plan reemphasizes our theme of owning bonds backed by DEDICATED sources of revenue versus bonds supported by GENERAL FUND BALANCES. There is a subtle but very important distinction between bonds that are backed by unlimited taxing authority and dedicated (and unlimited) taxing authority. The taxes raised for the bonds backed by the DEDICATED source can only be used to pay debt service.
    2. Stay away from bonds in areas where no one wants to live and pay taxes. The population of Detroit has shrunk from 2 mlln in the 1950s to 700,000 today. As much as 40% of the taxable lots are vacant.  Without taxable assets, revenue sources dwindle and bankruptcy judge needs to decide an “equitable” way of satisfying creditors.
    3. We believe the negative headlines will draw “new” attention to “old” problems and may result in some further retail redemptions. We do not believe the Detroit bankruptcy to be the “norm” and in fact, see most City finances improving with increased property values and tax revenues.
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