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Muni bond sell-off drives yields to 2-year highs

The annualized tax-free yield on a Bond Buyer index of 40 long-term muni bonds nationwide jumped to 5.86% on Thursday, up from 5.77% on Wednesday and the highest since January 2009.

January 14, 2011|By Tom Petruno, Los Angeles Times

Fears over deepening state and local-government budget woes have fueled a heavy sell-off in tax-free municipal bonds this week, driving market interest rates on some securities to two-year highs.

That surge in yields, if they stay up, could further complicate the financial picture for muni bond issuers, including California, by boosting their borrowing costs at a time when they already are severely short of funds to spend.

As the price of a bond falls, its interest yield rises. The annualized tax-free yield on a Bond Buyer index of 40 long-term muni bonds nationwide jumped to 5.86% on Thursday, up from 5.77% on Wednesday and the highest since January 2009.

In just over three months, the index's yield has soared by a full percentage point.

The slump in bond prices has hammered shares of many popular muni mutual funds. The Franklin California Tax-Free Income fund slid 6 cents, or 0.9%, to $6.59 on Thursday, the lowest price since May 2009. The shares have tumbled 10.1% since Aug. 31.

Historically, surges in muni bond rates have attracted yield-hungry individual investors, long the backbone of the muni market. Yet those investors remain "very cautious" about stepping in now, said Kevin Giddis, fixed-income head at brokerage Morgan Keegan Inc.

The latest sell-off marks a new phase in a muni slump that began in November. In the first phase the market was rocked by a rise in interest rates on longer-term bonds in general and by a rush of new bond issuance by many states and municipalities.

More recently investors have been spooked by fears of worsening state and local government budget troubles and the risk that some borrowers could renege on their debts.

Meredith Whitney, a Wall Street banking analyst who last month predicted on CBS' "60 Minutes" that a wave of muni defaults was coming, reiterated her grim view on CNBC on Wednesday, further darkening the mood.

Other bond market analysts have sought to discredit or downplay Whitney's predictions, noting that only a relative handful of muni issuers have defaulted since World War II. But on Thursday, New Jersey Gov. Chris Christie further antagonized the market by warning that rising healthcare costs for workers, if not reined in, would "bankrupt" the state.

George Strickland, who helps manage $6 billion in muni bond mutual funds at Thornburg Investment Management in Santa Fe, N.M., said that while he understood investors' concerns about fiscal turmoil, muni yields had reached "idiotic" levels compared with other interest rates.

The tax-free yield on 30-year California general obligation bonds was just above 6% in trading late Thursday, Strickland said. The interest is exempt from federal and state income taxes for California residents.

By contrast, the U.S. Treasury on Thursday issued new 30-year bonds at a yield of 4.52%. Treasury interest is federally taxable.

One continuing drag on the muni market is that muni mutual funds, a key source of demand for the bonds, have suffered net cash outflows for nine straight weeks as some small investors have fled. Since mid-November the funds have seen a net $22.7 billion leave, according to the Investment Company Institute. That's about 4.5% of total assets, which stood at $500 billion on Nov. 30.

Redemptions by fund investors often force portfolio managers to sell bonds to raise cash, further depressing the market.

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