Muni Manager Conf Call Notes

Some highlights from a well known muni bond fund management team conference call on 2/4.  Notes provided by a 3rd party.  I continue to believe that the muni bond space offers extremely attractive opportunities for retail investor’s taxable accounts.

General update:  The market is starting to return to normal. It still has a long way to go, but it’s progressed in the right direction.  We’re seeing more buyers, and we’re seeing a variety of different buyers.  The municipal bond fund industry is experiencing net inflows again, and these flows have to be put to work in the market. We’re seeing that dealers have a greater appetite to “inventory” bonds while the retail sector of the muni market remains strong. We’re seeing new deals get placed, which has helped secondary market trading.

Current marketplace:  Risk aversion still persists in all global financial markets.  The yields on T-bills are still extraordinarily low, but they are better than a month ago, when their yield was zero.  The 30-year Treasury bond-at 3.66%-is still at a risk-averse level compared to corporate bonds and high-yield munis. Most of the improvement in the muni market has been in the high-grade space.  High-yield munis have not performed as well and, by and large, high-yield munis are still extraordinarily cheap.

Ratios:  One ratio to note is the yield spread between AAA-rated GOs and BBB-rated revenue bonds.  Right now, according to Bloomberg, that spread is 393 basis points, compared to an average over the past 15 years of 83 basis points.  Clearly, we still have very wide credit spreads in the muni market.  In the high-grade space, which is much improved, munis are still extremely cheap.  High-grade, long-term muni yields are about 130% of Treasury yields right now.  While that ratio has dropped considerably, munis are still not correlated to long-term Treasury bonds.

State and local government:  There will continue to be headlines highlighting risks associated with the financial conditions of municipal borrowers, state and local governments.  The headlines are sensational to read, and the articles often cite a laundry list of services that these states and cities are going to eliminate to fill their budget gap.  Eliminating debt payment is not on the list. The State of New York just resolved its budget deficit for the current fiscal year through the combination of revenue increases and expenditure cuts.  We are waiting to see how the federal stimulus package addresses the respective budget deficits as well.

Examples of a decoupled market:  Though the market has done quite well since the beginning of November, it is also fairly decoupled.  Recently, there was a large deal issued on behalf of the Los Angeles Unified District. On this deal, there were more than $1 billion in orders for just over $100 million in bonds. That deal was rated AA-minus, which is what one would call the pristine or high-grade sector.  The flip side of that is a deal that came in California at the end of last week that was only a few million and was A-rated, just one notch lower.  The A-rated bond attracted only a few interested participants and, as a result, had to offer a much higher interest rate (7%) than the higher-rated bond.  The market recovery has been pretty uneven.  For example, BBB-rated universities are right now over 350 basis points wider than AAA bonds.  BBB hospitals are another 100 basis points wider than that. Tobacco bonds are a close to another 100 basis points wider than that.  The sectors in which we are heavy have recovered a bit, but the recovery is not even close to what we’ve seen in the pristine AAA and AA sectors.

Defaults:  The muni market remains a sector where defaults are relatively few. It does have a great history of protecting investors from principal losses.  When reading the headlines, there is a considerable amount of fear about increased credit risk.  That’s why we believe an investor has to do the proper credit work, understand the project and follow the changes in the financial condition of that project.  We have a staff here of credit analysts who spend their entire day analyzing the credit quality of tax-exempt borrowers on bonds that we own and bonds that we’re looking to buy.  That’s all they do.

Recap:  The tone is definitely better.  Munis are still cheap. The yields are still extremely attractive. There is still a long way to go for munis, and we’re pleased with the composition of our portfolios to take advantage of it.


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