Tax-exempt municipal bonds losing luster with investors

While tax-exempt, high-yield municipal bonds were all the rage after 2008’s economic collapse, they have since lost some of their appeal for investors. Some bond indexes reported their worst performances since 1994.

The recent downturn in the bond market is attributed to rising interest rates and the Federal Reserve’s recent tapering of their quantitative easing, or QE, asset purchasing program. Another contributor has been Detroit’s bankruptcy filing in July.

Bankruptcies by San Bernardino and Stockton also have played a role in the volatility of the municipal bond markets. But the broader economic recovery has helped stem the tide of large jurisdictional bankruptcies.

The 14th monthly edition of the High Net Worth Report by the Private Bank at Nevada State Bank noted that North Las Vegas remains on potential default watch lists.

The bank’s recent report follows Moody’s Investor Services’ decision to downgrade North Las Vegas to “Ba3” from “Ba1.” The rating outlook was revised to “negative” from “stable.”

Moody’s rating action affects approximately $427.9 million of outstanding rated debt secured by the city’s general obligation limited tax pledge. “Approximately, two-thirds of outstanding (general obligation limited tax) debt is additionally secured … by resources of the city’s water and sewer enterprises,” the Moody’s report said.

While analysts monitor economic developments in North Las Vegas, Nevada’s municipal debt load has remained relatively stable. The Private Bank report noted state debt is approximately $4.2 billion, or on a per-capita basis $1,543, which is below the national average of $3,636.

When combined with $23.5 billion in local government debt, the tally rises to $27.7 billion. Looking per capita, Nevada’s municipal debt total is $10,174, slightly higher than the national average of $9,332.

“Those borrowing levels are largely sourced to the financing of infrastructure and capital requirements due to the state’s growth in recent decades, as opposed to any shoring of short-term budget challenges through issuance of public debt,” the Private Bank report said.

The report also found that as the state’s economy continues to recover at a modest pace, an expanded tax base could help stabilize or deleverage public balance sheets.

Meanwhile, the tax-free status of most municipal bonds has meant local governments generally sell their notes at a lower cost than U.S. government Treasurys. The tax-exempt status has also been attractive to investors

“Tax-exempt instruments will continue to play a role in investors’ portfolios, even if the risk-reward profiles are constantly evolving and interest rates head upwards,” said Russell Price, executive vice president of The Private Bank.

Price said the appointment of Janet Yellen as chairwoman of the Federal Reserve has pushed talk of future inflation expectations back to the forefront.

“The new chairwoman will look to balance monetary policy and economic recovery in 2014, a significant challenge that may also impact the municipal bond market’s performance going forward,” Price said.

Contact reporter Chris Sieroty at csieroty@reviewjournal.com or 702-477-3893. Follow @sierotyfeatures on Twitter.