Investors in tax-exempt debt should be cautious about heeding recent reports about the possibility of widespread bankruptcy and default in the municipal market, and stop running away from solid, safe investments because of distorted opinions in the media.
That was the advice from top portfolio managers and traders at DWS Investments, the retail arm of Deutsche Bank’s global asset management division, given during a teleconference Wednesday aimed at dousing the recent firestorm of negative press about the municipal bond market.
The muni market has come under close scrutiny in the wake of recent comments by financial analyst Meredith Whitney, who predicted that 50 to 100 significant bond defaults totaling hundreds of billions of dollars would occur in 2011.
The bad press came to a head two weeks ago when fears about the potential for default and bankruptcy escalated into a sell-off in the municipal market that saw 30-year, tax-exempt triple-A yields cross the 5% benchmark.
Municipals rebounded as demand for higher yields helped pull them back down to under the “magic” 5% level for retail investors.
In addition, a new bill introduced in Congress to allow states to gain bankruptcy protection compounded the negative press — all against the backdrop of record outflows from municipal bond mutual funds to the tune of $4 billion during the week ended Jan. 19, according to Lipper FMI, which topped the old record of $3.1 billion set the week ended Nov. 17, by 29%.
Phil Condon, head of muni portfolio management for DWS, and Ashton Goodfield, head of municipal bond trading — who together oversee $30 billion in municipal assets — acknowledged that increased surveillance is crucial in making the proper investment decisions for retail investors’ portfolios.
They also recognized the financial hurdles faced by cash-strapped cities, states, and local governments, but stressed that because of the fundamental changes in the municipal landscape, overall, the muni market should not be considered as “homogenous” as it once was.
“We don’t want to minimize the stress municipalities are under,” Condon said, but for analysts to “sensationalize it” sends the wrong message to investors.
“I think a number of events made investors question bonds and that started the market seeing outflows,” Condon said. “Investors started seeing the price of their funds slide along with Treasuries and thought about all the other factors and weak financial conditions.”
“The Meredith Whitney comments came at the right time to continue these concerns among retail,” he added.
Condon and Goodfield said states are making an effort to balance their revenue shortfalls with cost-cutting.
“We disagree that the end result is default or bankruptcies across the board. Talk of allowing bankruptcies for the states just added one more layer of concern for the marketplace,” Condon said.
“Local governments with investment-grade debt are typically not over-leveraged, so debt service is manageable and makes up between 5% and 8% of a typical budget,” he said.
At the same time, other burdens, such as pension obligations, typically account for 10% to 15% of state budgets, while health care is also a heavy burden. “Debt is not the problem,” Condon added.
Goodfield, meanwhile, acknowledged the possibility of default or bankruptcy among some smaller, nonrated issuers this year, but said that risk is significantly diminished in the investment-grade arena.
“We’re not expecting the kind of default or bankruptcies even close to the magnitude that we have heard some analysts talking about in the press,” she said.
Goodfield said large issuers with investment-grade debt have more of a stake in the municipal market and are not likely to choose default or bankruptcy in troubled times because they rely heavily on the capital markets for their project and infrastructure needs.
