Corporate Bonds Rally As Fears Recede

By Patrick McGee
Of DOW JONES NEWSWIRES

JANUARY 20, 2012, 5:53 P.M. ET
Article from The Wall Street Journal

NEW YORK (Dow Jones)--Investors were snatching up bank bonds in the secondary market this week, pushing yields to multi-month lows as risk-perception in Europe subsides.

Investors showed follow-through buying on bank bonds offered to the market Thursday, when Goldman Sachs Group (GS), Citigroup (C), and Bank of America (BAC) offered a combined $7 billion of new debt.

"The fact we could absorb all that supply in a day is very telling," said John D. Ryan, portfolio manager at DWS Investments, who said investor appetite for riskier assets has picked up globally. "With rates where they are at, we've definitely seen a flood of issuance from quality issuers."

The three banks accounted for nearly half of the $14.5 billion of investment-grade debt issued this week, according to Dealogic. The first two weeks of the year saw $23.1 billion and $28.8 billion of volume.

In the primary market, yields are so low that banks can offer a decent-sized concession to entice investors, yet still be enthused with the overall low borrowing cost.

"They are happy with the all-in yields, and we are happy with 20-30 basis point discounts to where things were trading," Ryan said.

Yet just one borrower opted to take advantage of the favorable conditions Friday, and no senior unsecured debt was on offer.

The Bank of Nova Scotia (BNS) sold $2.5 billion of five-year covered bonds Friday, pricing the 1.95% coupon bonds to yield 1.977%, or 109.1 basis points over the Treasury rate.

That represents about 63 basis points in savings compared to Scotia's senior unsecured offering earlier this month, when it sold $1.25 billion of 2.55% coupon, five-year senior unsecured bonds priced to yield 2.593%, or 172 basis points over Treasurys. The Jan. 5 sale was part of a three-tranche, $2.75 billion offering rated Aa1 by Moody's Investors Service and AA-minus by S&P.

The three major deals from Thursday were some of the most actively-traded bonds in Friday's market.

The risk premium, or spread, on Goldman's 10-year bonds improved 17 basis points from issuance to 363, and the spread on Citi's 30-year bonds tightened 12 basis points from issuance to 285, MarketAxess data shows.

Bank of America's 10-year bond was the outlier, as the spread actually widened, or deteriorated, two basis points from issuance to 380 basis points.

Markit's CDX North America Investment Grade Index, a measure of health in the corporate bond market, was on track to improve 1.8% to 105.9 basis points, which would be the lowest closing level since August 5, when it was at 103. A lower level indicates improving sentiment.

On Thursday, Barclays Capital investment-grade corporate bond index improved one basis point to a spread of 221 basis points, the narrowest spread since November 14. The index has improved four basis points this week and 13 basis points year-to-date.

"People definitely came into this year more bulled up," Ryan said. "People are getting more comfortable that liquidity won't be a problem even if insolvency problems in Europe are unresolved."

The multi-day bond rally was initiated by a non-event--the absence of a market sell-off early this week following the Standard & Poor's move last Friday to downgrade nine euro-zone countries. The move stripped France and Austria of triple-A ratings, and lowered Italy by two notches to BBB-plus from single-A.

"The expectation was that European markets would react negatively, and they basically ignored it," said Mark Alexandridis, managing director of asset management at First Principles Capital. "All of these downgrades have been priced in. I don't think there was a soul on the planet who thought Italy was a single-A country last Thursday."

-By Patrick McGee, Dow Jones Newswires;             212-416-2382      ; patrick.mcgee@dowjones.com

Article from The Wall Street Journal

Are Muni Bonds Still Smart?

JANUARY 18, 2012, 7:41 P.M. ET
Article from Smart Money

Municipal bonds were among the few breakout stars of 2011, but some advisers warn the hot streak may fizzle out.

By JONNELLE MARTE

In last year's upside-down market, the once-forsaken muni bond became a surprise hit, offering investors safety and solid returns. But as their popularity continues to grow, some pros are warning investors their stellar run may be coming to an end.

With the fears of defaults now a distant memory, investors plunged nearly $5 billion into municipal bond funds in December -- the category's highest total in 16 months, according to fund researcher Morningstar Inc. That's a sharp reversal from the 5-month period that ended in May, when they yanked nearly $23 billion from these funds. And the money is still flowing in: municipal bond funds, including exchange-traded funds -- drew in in $1.1 billion for the week ended Jan. 11, their highest amount since March 2010, according to fund tracker Lipper.

Why the stampede back into municipal bonds? For starters, advisers say many investors who were spooked by grim predictions for large defaults in the municipal-bond market last year are returning now that it hasn't come to pass. Other investors are likely chasing returns, analysts say. The average long-term national muni-bond fund gained 9% in 2011, compared to a 2.1% gain for the S&P 500, according to Morningstar. "I don't think anybody was predicting such strong returns, says Jim Colby, senior municipal strategist and portfolio manager for Van Eck Global.

And while yields on the bonds hit record lows last week, advocates say the bonds still pay better yields than other kinds of bonds. The weighted average yield of bonds in the S&P National AMT-Free Municipal Series 2021 Index, which tracks investment-grade, tax-exempt municipal bonds, was 2.4% at the end of December, for a taxable equivalent yield of 4.35%. That compares to 1.9% for a 10-year Treasury bond. "We're still finding attractive yields," says Dan Loughran, senior vice president of OppenheimerFunds and leader of the Rochester municipal investment team.

Still, muni-bond bears say these investments are plenty risky. As part of the federal government's effort to reduce its massive deficit, several lawmakers -- as well as President Barack Obama -- have proposed cutting or eliminating the tax break on income from municipal bonds for high earners; as of now, muni-bond income is tax-exempt. If that tax exemption vanished, investors would demand higher yields, and muni-bond yields would jump dramatically, says , says Matt Fabian, managing director of Municipal Market Advisors, a market research firm. Bond prices fall when yields rise.

Another potential blow: approval of the so-called Volcker rule, a proposal that aims to limit the bets banks make with their own money, could reduce the number of banks buying municipal bonds, which could lower bond prices, says Fabian. And hot interest municipal bonds have seen over the last couple of months could backfire if an event spooks investors and causes them to flee from the funds, warns Fabian. "As fast as they're putting money in they can pull money out," he says.

On top of that, the recent rise in popularity is pushing down yields even just this year, giving the upper hand to issuers, who get to borrow at lower rates, says Fabian. For example, a standard Triple-A rated municipal bond yielded 1.73% as of Jan. 18, down from 1.93% on Jan. 2, according to Municipal Market Advisors. Even fans point out that muni-bonds' best days may be gone. "We've had yield plus price appreciation because the market has rallied," says Loughran,. "But I encourage people not to expect that from municipal bonds going forward."

Article from Smart Money

No Muni Miracle for 2012, Though Yields Are Enticing

By Carla Fried - Jan 18, 2012 2:37 AM GMT+0800
Article from Bloomberg

Barely a year ago, the municipal bond market was tarred as a horrible investment. The expiring taxable Build America Bonds program had triggered an uptick in new issues that created a supply glut, bond rates were on the rise and analyst Meredith Whitney told "60 Minutes" that defaults would amount to "hundreds of billions of dollars." From October 2010 through January 2011, municipal bond funds saw net outflows of more than $33 billion, while a benchmark municipal bond index fell nearly 5 percent.

Rumors of the municipal debt market's death were way off base. The default wave didn’t materialize and munis staged an impressive rally as U.S. bond rates tumbled across the board. The 10.7 percent total return for the Barclays Municipal Bond index in 2011 squashed the 2.1 percent total return of the S&P 500-stock index. It also bested the 7.8 percent return of the Barclays Aggregate Bond index, the benchmark for taxable bond investments that’s mostly composed of government and corporate bonds. Pimco's Muni Move

That muni bonds are alive and kicking was underscored when Pacific Investment Management Co., which runs the world's largest bond fund, boosted its holdings of U.S. muni debt to the highest level in more than five years, according to data compiled by Bloomberg. It's not that Joe Deane, who manages $16 billion as head of municipal-bond investments at Pimco in New York, expects a repeat of 2011 returns. More likely is a return of  6 percent to 7 percent this year, he told Bloomberg.

The reason for lower return expectations: After hitting a late 2010 high of 3.6 percent, the yield on AAA rated 10-year municipal bonds is now 1.8 percent. From that level, it's unrealistic to expect much in the way of price gains that come from falling yields. James Kochan, chief fixed-income strategist at Wells Fargo Funds, expects muni total returns in 2012 to be in line with the coupon interest paid. “We’re not likely to get price appreciation on top of that.”

That means you might get 1.9 percent if you stick to a 10-year AAA rated municipal bond, close to what a 10-year Treasury pays out. Of course, if you’re investing in taxable accounts, the 1.9 percent muni yield is worth a lot more because its interest payout isn’t subject to federal income tax, while Treasury bond income is. The 10-year Treasury would have to pay 2.6 percent to be a better deal than the muni for an investor in the 28 percent federal tax bracket, or 2.9 percent for someone in the top 35 percent federal marginal tax bracket. Finding a Yield Advantage

Bond pros say there’s an opportunity to pocket even more yield. “Go down the credit scale just a little bit and you can pick up sizable yield advantages over Treasuries,” notes Chris Alwine, head of Vanguard’s municipal bond team. Don’t worry, this isn’t about venturing into junk. Rather, all you need to do is set your sights on the lower tiers of investment grade bonds, he says: AA, A and BBB.

For example, 10-year single A rated tax-exempt bonds yield 3 percent, Kochan points out. That's 150 percent of the Treasury bond, a rich advantage given that the average for 20 years prior to the financial crisis was 90 percent. For investors in the 28 percent bracket, that 3 percent is the taxable equivalent of 4.2 percent. If you’re paying the top tax rate of 35 percent, you’d need to earn 4.7 percent in a taxable bond to match the 3 percent muni yield. Good luck finding that in the high-grade pool these days. The Bank of America/Merrill Lynch index of investment grade corporate bonds has a yield of 3.8 percent.

One obvious risk bond pros note is that you can only get those fatter yields in intermediate and longer-term issues. “But we’ve got a very benign interest rate environment with the Federal Reserve holding rates low through at least the middle of 2013,” says Anthony Valeri, fixed-income strategist at LPL Financial. He also notes that the extra yield on longer issues will provide some buffer if we see a rise in rates this year. “It’s just too early in the cycle to be overly cautious about rising interest rates,” says Kochan. Diversified Funds

Municipal bonds are one investment where hiring a professional fund manager makes a ton of sense. They have the analysts to ferret out good investment-grade values, and you get the broad diversification that helps mitigate default risk. Fidelity Intermediate Municipal Income (3.35 percent yield; $10,000 minimum; 0.39 percent expense ratio) and Vanguard Intermediate Term Tax-Exempt (3.51 percent yield; $3,000 minimum; 0.20 percent expense ratio) earn high marks from fund research firm Morningstar. Another option is the iShares S&P National AMT-Free Bond Fund, the biggest exchange-traded fund tracking municipal bond debt, which is trading near a record high.

Franklin Federal Tax-Free (4.27 percent yield; $1,000 minimum; 4.25 percent initial load and 0.62 percent expense ratio) also gets the nod from Morningstar. Co-manager Carrie Higgins says the fund gets "substantially more yield in the 10- to-20-year range." Its yield advantage over  the Vanguard or Fidelity funds comes from focusing on longer-term bonds. The fund's portfolio has an average maturity of 20 years, about four times that of the Vanguard and Fidelity intermediate portfolios. Its expenses are also significantly higher.

That extra yield may be enticing. In volatile periods, however, a concentration in longer muni bonds can work against investors. For example, in 2008 the Franklin fund's total return was a negative 7 percent, while the Fidelity intermediate portfolio lost 0.96 percent and the Vanguard fund lost 0.14 percent. (Carla Fried is a freelance writer based in California.)

To contact the editor responsible for this story: Suzanne Woolley at swoolley2@bloomberg.net

Article from Bloomberg