We already own quite a bit of preferred shares issued by Annaly Capital Management (NLY), but I'm re...
You Don’t Need to Run from Muni Bonds
08/08/2011 12:53 pm EST
State and local governments are taking solid steps to avoid defaults, which means the dire predictions of the past year have not yet come to pass, and Richard Band of Profitable Investing explains why he thinks there are several opportunities in the sector.
Now Richard, lately, you know, there’s been a lot of turmoil in the muni bond market and retail investors have disappeared, and Meredith Whitney, famous for having called the banking crisis ahead of time, has said that munis are really heading for maybe dozens, hundreds of defaults, and she recently doubled down on that prediction and said she feels more correct about this than anything she’s ever said. So, where do you stand?
Well, I have great respect for Meredith and her ability to call the banking crisis certainly, but I think she’s gone out on a limb here with the Muni forecast.
The evidence seems to suggest that the finances are improving for most municipalities. State governments are showing an increase in their tax revenues over last year.
Pretty robust. It’s still in the single digits, but the mid-single digits. Even local governments are starting to experience a little bit of an uptick in their tax revenues. They’re much more dependent on real estate taxes, of course.
So, I don’t see any kind of an Armageddon happening. In fact, the defaults this year so far are running at a slower pace, much slower pace, than they were in 2010, which was lower in turn than 2009. So, where is this Armageddon coming from?
Well, on the flip side of things, we’ve seen some of the states—obviously Wisconsin, Ohio, Michigan, very highly publicized, New Jersey, New York State—we’ve seen moves by governors of both parties to try to get their fiscal houses in order in many parts of the country, haven’t we?
Yes. They have to do that, Howard, because really municipal-bond interest expense is a small item in most state and local budgets. We’re talking about maybe in most cases five to seven cents on the dollar for a municipal budget will go to debt service. It’s a small amount. You’re not going to be able to solve a municipality’s problems by defaulting on your debt.
You have to deal with things like union benefits and things like that.
Medicaid. All of the benefit packages are really the issue. That’s the 300-pound, 500-pound gorilla in the room. So, states are dealing with that issue.
Curiously, as a result of all of all this publicity by Meredith Whitney and others, I think states are getting their account together, and avoiding the catastrophe she was predicting.
Well, that would be good news. So, if you like Muni bonds, can you mention one or two vehicles that people should use?
By far my favorite vehicle is the closed-end funds issued by the Nuveen and the BlackRock family of funds. They trade on the New York Stock Exchange. They can trade either at a discount or a premium to net asset value. I try to buy them whenever they’re at a little discount, maybe 3% to 5% discount.
The best of these funds are yielding over 7% tax-free monthly dividends. Boy, do I love to see those dividends credited to my brokerage account every month. Here, I hear people are screaming about municipal Armageddon, and I’m just getting richer every month. It’s wonderful.
So, look at the Nuveen or the BlackRock fund—and always look for the word “quality” in the name of the fund, because that means the manager is focusing on higher-grade securities. You don’t want to buy bonds from a municipal incinerator that’s going bankrupt or something like that. You want high-quality bonds that will not default.
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