Personal Finance


August 12, 2011


Muni investors ‘keep their heads’ after S&P cuts ratings

Aug. 11 (Bloomberg) -- Individual municipal-bond investors aren’t fleeing the market after Standard & Poor’s lowered the credit rating of thousands of bonds.

The ratio of buy orders to sell orders, a measure of investor demand, was 2.5 for municipal-bond trades on the BondDesk Group LLC platform yesterday, meaning there were more buyers than sellers, said Chris Shayne, senior market strategist for the group, a bond marketplace that works with dealers, advisers and discount brokers. That ratio showed demand was about normal and up from earlier in the week when demand was “substantially” weaker than normal, said Shayne, who’s based in Mill Valley, California.

Investors may not be dumping their bonds in part because they’re more focused on the underlying ability of issuers to repay principal and coupons, said Tom Spalding, who oversees about $10 billion in municipal securities in mutual funds and closed-end funds at Nuveen Investments Inc. in Chicago.

“They’re taking a longer-term view,” Spalding said. “The overwhelming evidence is that municipal credit is still a relative safe haven for investors.”

Flows this week have been mixed in the mutual funds Spalding manages with “modest” inflows to short-term municipal-bond funds and similar outflows from long-term funds, he said.

Collateral Damage

“We have not seen the collateral damage in muni land,” said Marilyn Cohen, president of Los Angeles-based Envision Capital Management Inc., which manages $328 million in fixed- income assets for individuals. “People were braced for it. They understood it does not mean that the credit metrics have deteriorated immediately.”

The Dow Jones Industrial Average fell about 520 points, or 4.6 percent yesterday, to the lowest level since September 2010. Standard & Poor’s assigned AA+ ratings, the second-highest investment-grade rating, to about 11,500 municipal securities this week, according to data compiled by Bloomberg. The affected bonds generally are tied to the federal government, which lost its AAA long-term credit rating from S&P on Aug. 5.

“Getting in and out of the municipal market causes its own friction, and I’m not going to do it willy nilly because everyone is running around with their heads cut off,” said New York-based Thomas Dalpiaz, who oversees $280 million as senior vice president of Advisors Asset Management Inc. “It’s my job to keep my head when everybody is losing theirs.”

Wait and See

Individual investors generally don’t sell bonds as quickly as they may sell stocks in reaction to bad news, said John Hallacy, head of municipal research at Bank of America Merrill Lynch in New York.

“They might wait a couple of days to see how things shake out before they decide what they are going to do, and they also need time to talk to their financial advisers,” he said.

Investors pulled about $14.5 million out of municipal-bond mutual funds on Tuesday, the seventh straight day of flows from the funds, according to data from TrimTabs Investment Research. There was about $861 million in total withdrawals from U.S. municipal-bond mutual funds in the week ended Aug. 3, before the downgrade, and that was the greatest weekly outflow since April, according to Lipper US Fund Flows.

Fund Withdrawals

Mutual-fund investors took money out of the funds for six straight months beginning in November 2010, according to data from Chicago-based Morningstar Inc., including $13 billion in outflows in December, the month when analyst Meredith Whitney forecast that there could be 50 to 100 “sizable” municipal- bond defaults. From May through July investors were adding money to the funds, Morningstar said.

“There’s no parallel,” in current fund flows to the outflows municipal-bond funds experienced in late 2010, said Spalding.

Municipal bonds fell 0.04 percent this week through yesterday, as measured by the Bank of America Merrill Lynch Municipal Master Index. Prerefunded municipal bonds, or those backed by Treasury bonds held in escrow, gained 0.07 percent, as measured by the Bank of America Merrill Lynch Municipal Prerefunded Index.

Some investors may be holding on to municipal-bond investments because there are few other safe havens available, said Robert Kane, founder and chief executive officer for BondView, which provides bond-market data for advisers and individual investors.

“There’s a kind of tug-of-war going on here with people wanting muni bonds and thinking longer term, and people thinking ‘Gee, I want to get out,’” he said. “But if you do get out, where do you go?”

Signs of Selling

There were some signs of selling following the U.S. downgrade. Shares of the iShares S&P National AMT-Free Bond Fund, an exchange-traded fund, closed Monday at a 1.77 percent discount to its net asset value, or the underlying value of its holdings, the largest discount for the fund since December 2010, according to data compiled by Bloomberg.

That discount may be because shares of the exchange-traded fund are more liquid than bonds sold over-the-counter, so market movements may show up in its shares before they are reflected in prices of the underlying bonds, said Matt Tucker, head of fixed- income investment strategy for BlackRock Inc.’s IShares unit. On Wednesday the shares closed at a 0.77 percent discount to net asset value.

No New Issuance

Closed-end municipal-bond funds traded Monday at an average discount of 8.39 percent to their net asset values, the largest discount since April 2009, said Cecilia Gondor, executive vice president at Miami-based Thomas J. Herzfeld Advisors Inc. The discount narrowed to 5.48 percent at the close of trading Wednesday.

Declining new issuance has limited the supply in the municipal-bond market, and many investors value the tax-exempt income provided by the bonds, said Josh Gonze, a co-portfolio manager who oversees $6.5 billion in municipal-bond assets at Thornburg Investment Management Inc. in Santa Fe, New Mexico. The funds he manages have not seen any significant inflows or outflows this week, Gonze said.

There was $141 billion in municipal-bond issuance in 2011 through July, compared with $216 billion in the first seven months of 2010, said Thomas Doe, chief executive officer and founder of Concord, Massachusetts-based Municipal Market Advisors.

Best Defense

Bonds issued by providers of essential services such as utilities should be less vulnerable to the effects of any future cuts in government spending, said Howard Cure, director of municipal-bond credit research for Evercore Wealth Management LLC in New York, which oversees about $2.9 billion.

Evercore recently purchased bonds issued by the Puerto Rico Electric Power Authority that mature in 2019 at a yield of 4.04 percent. Interest from Puerto Rico municipal bonds is generally exempt from state and local income taxes for residents of any state.

“We think that diversification is our best defense,” said Elizabeth Fell, head of U.S. fixed-income strategy at Barclays Wealth, which manages about $272 billion. Fell, who’s based in New York, is advising clients to hold general-obligation and certain revenue bonds.

There may be better opportunities among high-yield municipal bonds, which individual investors may not be able to analyze, said Jason Thomas, chief investment officer at Aspiriant, which manages about $7.5 billion.

No Flashing Sign

“The municipal-bond market is driven by the retail investor, who is drawn to the apparent safety of general- obligation municipal bonds,” said Los Angeles-based Thomas.

About 37 percent of municipal bonds are held directly by households and 32 percent is held by mutual funds, according to U.S. Federal Reserve data.

Bond investors who purchased individual bonds with a long- term time horizon generally should not sell, Kane said. They should selectively trim holdings with very low interest rates or long time horizons, and bonds likely to be downgraded.

“The fundamentals aren’t flashing a red warning sign,” he said.

Market-Wary Investors Seek Ways to Insure Millions in Cash (1)

Aug. 12 (Bloomberg) -- U.S. investors seeking safety in cash amid the market turmoil can take advantage of several methods to insure millions above the Federal Deposit Insurance Corp.’s $250,000 limit.

A husband and wife could each have $250,000 in individual bank accounts, the maximum covered by FDIC insurance, and $250,000 each in retirement accounts such as IRAs invested in bank products rather than mutual funds or annuities. They also each can set up $250,000 trust accounts naming each other as beneficiaries and deposit another $500,000 in a joint account, where each co-owner is insured up to $250,000.

“That total comes to $2 million fully insured,” said FDIC spokesman David Barr.

Investors are holding onto cash amid concern the U.S. economy may lapse into another recession. Cash held by U.S. banks surged 8.4 percent to a record $981 billion during the week ending July 27, the Federal Reserve said in an Aug. 5 report.

“The key is to try and maximize the productivity of that cash,” as yields are approaching zero on some money-market funds and bank products, said Tom Dunn, who specializes in cash management for clients with at least $1 million to invest in federally insured programs. Dunn is senior vice president of investments for First Financial Equity Corp. in Dallas.

For those seeking insurance above the FDIC limits at one bank, the Promontory Interfinancial Network LLC will split up a large amount of cash among several banks to stay under the cap. The Arlington, Virginia-based company has been offering this service, known as a certificate of deposit account registry service, or CDARS, since 2003.

CD Network

A customer with $1 million who uses one of the participating banks may have the cash placed in CDs at five different banks, said company spokesman Phil Battey. Each CD is worth less than $250,000 to make sure any interest earnings are also insured, he said.

The network includes about 3,000 banks and savers can insure up to $50 million through CDs in multiple banks. The average holding for individuals using the service is about $925,000, said Battey. Fees for the service are embedded in the offering rates.

Similar services exist that split large deposits into money-market deposit accounts at multiple banks to stay under FDIC limits. Money-market deposit accounts may be FDIC insured while money-market mutual funds, even if sold at a bank, are not, said Barr, the FDIC spokesman.

Deposits Rise

Institutional Deposits Corp. provides an interest rate of 0.3 percent to investors and has $745 million in money-market deposit accounts through its network of 184 banks, said Bill Burdette, president of the Miami-based company.

Deposits through the Federally Insured Cash Account, which offers up to $20 million of FDIC insurance at a current rate of about 0.40 percent, increased 7 percent in the last week, said Eric Lansky. Lansky is a director at StoneCastle Partners LLC in New York, which runs the FICA program. Both FICA and IDC primarily serve businesses and nonprofits, and some high-net- worth investors.

“A lot of our customers have more than $250,000 that they want to insure,” said Robin Loftus, chief operating officer for Security Bank in Springfield, Illinois. The community bank participates in the CDARS and IDC programs because some affluent customers want CDs and others prefer money-market savings accounts for quicker access to their funds, she said.

Rates May Increase

Consumers who use the networks should make sure they don’t have other accounts at banks where the money is placed that may push them over the insured limits, said Greg McBride, senior financial analyst at, a unit of Bankrate Inc.

Savers who want to put their money in CDs should do so now because rates will continue to drop, said Dan Geller, executive vice president of Market Rates Insight in San Anselmo, California. “It’s inevitable as long as the current economic conditions remain,” he said.

JPMorgan Chase & Co. lowered its yield in the last week to 1.75 percent from 2 percent for a new five-year CD with a minimum deposit of $10,000, Tom Kelly, a spokesman for the New York-based bank, said in an e-mail on Aug. 10.

The national average yield as of Aug. 10 on three-year CDs is 0.91 percent and 1.54 percent on five-year CDs, according to North Palm Beach, Florida-based The top yielding online, FDIC-insured savings accounts are returning 1.1 percent, data show.

‘Problem With Cash’

The seven-day compound yield of the average taxable money- market fund was 0.02 percent as of Aug. 9, according to IMoneyNet, a research firm based in Westborough, Massachusetts, that tracks money funds.

“That’s the problem with cash,” said Greg Peterson, director of research at Ballentine Partners in Waltham, Massachusetts, which advises clients who typically have a net worth of at least $20 million. “It’s not going to yield much because interest rates are so low.” The average rate of inflation this year through June was 2.8 percent, according to Bloomberg data.

Peterson said his firm started selling stocks and purchasing lower-risk assets in May and has recommended short- term, investment grade corporate bonds for those that need income. Investors should have a six-month reserve of cash and bonds, he said.

Deposit Fees

Banks may start charging retail customers for large deposits because they’re already holding so much cash, said Geller of Market Rates Insight. That’s because deposits cost banks money for FDIC insurance assessments while loan demand remains weak, Bankrate’s McBride said.

Unusually high cash deposits prompted Bank of New York Mellon Corp., the world’s largest custody bank, to impose fees of 0.13 percent on some institutional clients.

“Some clients during these times of market volatility have moved out of equities and are sitting on cash or in general want to keep their powder dry to get back in,” said Ram Subramaniam, head of products for TD Ameritrade Holding Corp.

Brokerages including TD Ameritrade and Charles Schwab Corp. offer FDIC-insured CDs, known as brokered CDs, from various banks. A one-year brokered CD bought through Schwab is yielding 0.5 percent, said Jeff Morley, vice president of portfolio consulting at the San Francisco-based firm.

While yields may be “slightly higher” on some brokered CDs, they’re not without risk, said McBride of Bankrate. That’s because it may not be as simple to get out prior to maturity by paying a penalty as with a traditional CD, McBride said. Brokered CDs are sold on the secondary market and “what you get is what an investor is willing to pay for it,” he said.

‘Kick Yourself’

Investors may have uninvested cash in brokerage accounts “swept” into FDIC-insured accounts, earning 0.01 percent, at TD Ameritrade and Schwab. Clients may get a higher yield on those funds if they move them into a Schwab high-yield checking or savings account that pays as much as 0.4 percent, said Morley.

Diahann Lassus said she’s raised the maximum cash allocation in her clients’ portfolios in the past couple of weeks “to build an extra cushion because of the volatility in the market, and so we can sleep at night.” Investors shifting some of their assets to cash should consider money-market accounts, Treasury bills, bank CDs or bank savings accounts, said Lassus, who’s president of the fee-only advisory firm Lassus Wherley in New Providence, New Jersey.

“If you sell everything and go to cash you’re going to kick yourself,” she said. “It’s very hard to get back into a market once you’ve done that.”


August 12, 2011