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Muni Bond Prices May Drop More

Securities: Downgrade hurts California's image, but as yields rise, some investors might find the issues more attractive.


Investors in California tax-free municipal bonds are seeing the market take away some of what it gave them last year. But the losses on many muni bond mutual funds still are modest compared with last year's hefty gains.

With Tuesday's power-crisis-related downgrading of the state's general obligation bonds by Standard & Poor's Corp., some experts warned that California muni bonds of all kinds could see further downward pressure on their market prices in the near term.

Those prices have been falling for the last few weeks, hit by a double whammy: growing concerns about the long-term effects of the state's power woes and a rise in yields on long-term bonds in general as investors have focused on the potential for a U.S. economic recovery.

Though the market was anticipating that California's bond rating would be cut, some traders said they expected only a one-notch drop, not the two notches S&P announced.

Much of the downgrade has "already been priced into the market, but maybe it will be felt psychologically," said Robert Gore, a muni manager at brokerage Crowell Weedon & Co. in Los Angeles.

As bond prices fall, yields rise. On average, long-term California general obligation bonds in recent weeks have been trading at yields that are about 25 basis points--one-quarter of a percentage point--higher than bonds of higher-rated states, analysts say.

For 10-year bonds, for example, California general obligation issues yield about 4.75% now, versus about 4.5% for bonds from top-rated states.

Because that 4.75% yield is exempt from federal and state taxes, the true yield for investors is higher. For someone in the combined federal and state tax bracket of 37.4%, a 4.75% yield is equal to a 7.6% taxable yield.

Some bond experts said the higher yields might prove to be a buying opportunity for long-term investors who believe the state will resolve its energy crisis.

"A lot of people who are buy-and-hold [investors] figure it's going to be OK, and they would be getting attractive yields to buy" now, said Dan Solender, a California muni bond portfolio manager for Vanguard Group. "In the short term, there's a lot to be worked out, but [the state] has to find a way to resolve this, and they will."

Demand for California bonds remains high with institutional investors but may be waning at least temporarily among individual investors. "I deal more with retail investors, and I definitely see more people here saying, 'I want to sell,' [because of energy worries] rather than, 'I want to buy,' " Gore said.

But Zane Mann, publisher of the California Municipal Bond Advisor newsletter, said investors tempted to sell because of the credit downgrade should remember how quickly Orange County's bonds--and finances--recovered from its 1994 bankruptcy, which was a far more dire event.


California Muni Funds: A Sampling

The plunge in market yields on long-term bonds last year, as the economy slowed, dramatically boosted the value of older, higher-yielding bonds. That produced hefty "total returns" on municipal bond mutual funds-meaning principal appreciation plus interest earned. This year, however, many funds are posting negative total returns as market yields have rebounded.

Total return:


Fund 2000 YTD Bernstein Calif. Muni +8.6% +0.9% Franklin Calif. Tax-Free A +12.6 +0.6 Alliance California A +10.0 +0.1 Smith Barney Calif. Muni A +16.1 -0.4 T. Rowe Price Calif. Tax-Free +12.8 -0.4 Oppenheimer Calif. Muni A +12.7 -0.5 Lord Abbett Calif. Tax-Free A +14.7 -0.5 Vanguard Cal. Insured Long-Term +15.2 -1.0 USAA Calif. Bond +14.4 -1.1 Dreyfus California Tax-Exempt +15.3 -1.5


Sources: Morningstar Inc., Bloomberg News

Yields on the Rise

Municipal bond yields in general have been rising in recent weeks, tracking a jump in long-term Treasury bond yields, as bond traders have focused on the idea that the economy might rebound sooner than later--boosting demand for credit and also fueling inflation worries.


Yield on Moody's Investors Service index of A-rated

20-year muni bonds, monthly closes and latest

April latest: 5.43%

Sources: Bloomberg News, Times research

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