Fourth Quarter 2009 Tax-Exempt Muni Bond Market Review
January 15, 2010
Author(s):
Fourth Quarter 2009 Fixed Income Sector Returns (Pre-Tax)*
Fourth Quarter 2009 Fixed Income Return Per Unit of Duration*
*as of 12/31/2009 Source: Barclays Capital
Market Review
The municipal bond market experienced a dramatic rebound in 2009 as the market benefitted from record mutual fund flows, municipalities’ ability to access the capital markets and the introduction of the Build America Bond Program. Increasingly, investors are looking to the municipal bond market for preservation of principal that is exempt from taxes. For the year, the municipal market saw more than $78 billion of money invested into open-end municipal bond funds, more than twice the annual record seen back in 20031 as the steepness of the municipal curve prompted investors to look for more yield further out on the curve. As a result, municipal money market funds, with extremely low yields, experienced more than $92 billion of outflows in 20092. This increased demand for longer tax-exempt bonds has allowed municipal yields to remain at historically low levels.
This increased demand and low interest rate environment has facilitated issuers’ ability to access the capital markets. After seeing issuance through the first seven months of the year trail year-over-year issuance by almost 20%, the market saw a significant increase during the final four months of the year3. A large portion of this issuance came to market in the form of taxable Build America Bonds, where 35% of the interest cost will be subsidized by the Federal Government. This structure has become increasingly attractive to both municipal issuers and investors. While this program is currently slated to expire at the end of this year, it is largely anticipated to continue into 2011 with potentially lower levels of subsidy and more focused purposes of funding. This reallocation of municipal debt to the taxable market has provided strong technical’s for the tax-exempt market with overall improvement in the price of most high quality municipal bonds as overall issuance of tax-exempt municipal debt has slowed.
While there are many indications that the U.S. economy has begun to show signs of improvement, many municipalities continue to experience budget shortfalls, with most states projecting further declines in tax collections in the coming years as unemployment rates remain high and consumer spending continues to be sluggish. Historically, municipal credit generally lags an economic recovery by several quarters after a recession ends. The latest report by the Nelson A. Rockefeller Institute of Government shows that overall tax collections in the third quarter fell almost 11% when compared to the same quarter in 2008. The report goes on to say that the first three quarters of 2009 experienced the largest decline in state tax collections since at least 1963. Municipalities appear to have faired better at the local level compared to the state level, as local municipalities rely more on property taxes for revenues, which tend to be a more stable revenue stream despite the housing market decline. However, this could change as the general decline in housing values may result in a reduction in property tax revenues as home prices are re-evaluated. While the fundamental condition of the municipal bond market will have to be monitored closely going forward, we feel that this sector will not experience large scale defaults as the economy struggles to recover from this recession.
Past performance is no guarantee of future results. Indices are gross of fees and are not available for direct investment. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
The indices designed, calculated and published by Barclays Capital are registered trademarks.
1Source: Barclays Capital, AMG Data
2Source: Barclays Capital, IBC Money Fund Report
3Source: RBC Capital Markets, The Bond Buyer
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