Junk Bonds Outperforming Safest Debt in 2015: Muni Credit

Municipal bonds, which are the riskiest, could rally into next year but also outpace the local debt market of $2.7 trillion for the longest stretch in four years, this as investors do not see any letup in the search for yield.

In 2014, Munis rated below investment grade and earned 13%, on course for the biggest annual gain in two years following a decline last year of 5.5% according to data from Barclays Plc. For the entire tax-free market in consecutive years dating back from 2009 and 2012 junk munis have not outperformed.

To see a list of high yielding CDs go here.

As stated by Daniel Solender with New Jersey-based Lord Abbet & Co., now with a healthy economy and interest rates at all-time lows, interest is likely to extend into 2015 specific to speculative grade investments.

Solender added that as the extra yield demanded by investors is still above averages prior to 2008, there is still room for gains. This as the while the benchmark rate was lowered by the Federal Reserve near zero. The debt is recommendation by Morgan Stanley going into next year.

He added that more than likely, it will outperform because the market’s credit quality shows improvement in light of the current economic situation. Solender helps in overseeing $16 billion munis stated that still a little wider are spreads, more so then where they were before activity by the Federal Reserve.

As shown in data from Lipper US Fund Flows, because interest rates are at historic lows, investors have added money to riskier US mutual funds, as well as local debt for 18 of the last 19 weeks.

As of December 1, an index of speculative grade munis yields roughly 6.5%, which is approximately 4.9% points over the measure of local debt and top-rated state. Barclays data also shows since April of 2006, there is an 0.8% point difference above average.

Alan Schankel, managing director with Janney Montgomery Scott and who forecasts that 10-year Treasury yields will hit 2.47% in the final quarter of 2015, close to 0.2% point over current levels feels that the rise in interest rates may not be significant enough in 2015 to reduce investors’ appetite for riskier debt.

Schankel said that to some extent, investors are stretching for yield by extending maturities but the other way is to go down the credit curve that would definitely include high yield.

In a December 1 report from Michael Zezas, chief muni strategist for the New York Bank said that the suggestion from Morgan Stanley is to use this quarter’s declines to add high yield munis, specifically tobacco bonds, referring to lower rated debt as being underpriced when using criteria such as downgrade risk.

The demand for junk borrowings last month was beneficial to a charter school in Denver. The Science Technology Engineering and Math school sold tax-exempt bonds in the amount of $14.7 million using a state authority to refinance debt. The school that serves 6 through 12 grades has 983 students enrolled for 2015-2016.

Rated one level below investment grade is debt, which is scheduled to mature in November 2049 and priced to yield 5.19%, which is 2.1% percentage points over the 30-year munis benchmark.

Yields were lowered by the Colorado school up to 0.08% point during the sale, as stated by Steph Chichester, president of North Slope Capital Advisors in Denver and also the financial advisor on the offering of the bond.

At this time, investors are interested in riskier securities due to low volume and low rates that create a “perfect storm fashion” for borrowers.

Although issuance across the municipal market this year is down nearly 1.4%, sales from lower rated entities have slide further.

This year through November, issuers rated below investment grade sold $1.6 billion of debt, this compared to all of 2013 at $4.2 billion. Bloomberg data also shows that the tally for 2014 does not include Puerto Rico’s junk rated $3.5 billion general obligation sale in March. For this sale, hedge funds were primarily used opposed to traditional muni investors.

Cut to speculative grade in February, developments in Puerto Rico could have a bearing on performance of high yield munis next year.

With $8.6 billion of junk rated debt, the territory’s Electric Power Authority is scheduled to release a debt restructuring plan sometime early March, which in the municipal market would be the largest yet. The main supplier of electricity for the island had late balances in September of $1.75 billion among residents and businesses, as well as government entities.

According to Schankel, the concern is that this is an unknown and a significant part of the municipal high yield market.

Adding to the case for high yield is the US economic expansion by increasing localities’ ability to pay off debt. On pace to fall for the fourth consecutive year is first-tie municipal defaults, as stated by Municipal Market Advisors in Massachusetts.

In a Bloomberg survey consisting of 87 analysts who provide median forecasts, in 2015, the country’s gross domestic product is expected to climb 3%, which would be the largest annual expansion since 2005.

Solender stated that if rates do move upwards, it would show an improvement in the economy but also that improvement should be seen with credit quality as well.

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Don Miller

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