Clinton tax plan pushes muni bond prices higher

February 22, 1993|By Robert Hurtado | Robert Hurtado,New York Times News Service

President Clinton's plan to impose higher taxes and cut the deficit by $500 billion within four years gave municipal bond prices a boost last week, as investors turned to tax-exempt municipals as a hedge against the coming increases.

But some analysts cautioned that the rush to these tax shelters has created a greater demand than the current available supply of municipal bonds can accommodate.

As a result, analysts said, investors are paying premium prices for the available issues, and some may end up buying bonds they might normally shun as too risky.

"The scarcity of municipal bonds will drive up prices, but also allow some bond issues to come to market despite questionable quality," Richard A. Ciccarone, director of tax-exempt fixed-income research for Kemper Securities Inc., said. "Credit quality is still weak, and I suggest investors be selective."

Last week, municipal bond yields fell about seven basis points, or hundredths of a percentage point, on average. Ten-year, AA-rated general obligation bonds that were yielding 5.11 percent at the beginning of the week, for example, were at 5.04 percent by week's end, according to the Bloomberg Fair Value Index, a measure of the relative value of municipal bonds based on historical patterns in that market.

For an investor in the current 31 percent tax bracket, the equivalent taxable yield without including local taxes is 7.30 percent. At the proposed 36 percent tax rate, the bonds' after-tax yield would be 7.87 percent.

Although municipal yields slipped last week, last week's historic lows in the 30-year Treasury bond made the municipal securities attractive by comparison. The ratio of general obligation municipal bonds with yields equivalent to 30-year Treasury bonds reached 83 percent last week, Ciccarone said, while 86 percent of municipal revenue bonds had yields equivalent to 30-year Treasuries. Normally, he said, those percentages would be in the 70 percent range.

With President Clinton proposing an increase in the top income-tax rate to 36 percent on individuals earning more than $115,000 per year and couples earnings more than $140,000, traders said it made sense that many investors were flocking to tax-free municipal bonds to shelter their investment income.

Still, the approximately $2 billion of new issuessold last week was about $2 billion less than the 1992 weekly average, when many municipal issuers were refinancing. Municipal analysts report that during the next 30 days, issuers are scheduled to sell only $4.05 billion of new debt, according to The Bond Buyer.

Despite the investor demand, and despite continued talk of new "infrastructure" projects, the supply of municipal bonds is not expected to increase soon, bond traders said, because of the many administrative and regulatory steps involved in bringing out new municipal issues.

And despite the lower interest rates, there is not expected to be a vast amount of refinancing by municipalities, either.

"Many of those type of financings were already done last year," Ciccarone said. "Beside that, there are the refunding limitations imposed by the 1986 Tax Reform Act."

* The lure of the municipal market has attracted institutional investors, which is likely to result in more and more municipal offerings being tailored to the specific needs of these large buyers.

For example, the West Virginia Parkways Economic Development and Tourism Authority recently sold $119 million of revenue refunding bonds. Only 10 percent of that amount was sold as a straight bond issue, with the rest offered as convertible bonds, floating-rate notes and other so-called derivative products. Such derivatives are beginning to make up a greater portion of the retail market, since a lot of the institutional investing is done on behalf of mutual funds.

The West Virginia offering through Lehman Brothers saved the state agency $7.3 million in interest payments, compared with what it would have been paid under the 1989 offering that the new issue is refinancing.

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