Forget about whether municipal bonds, a staple of many fixed-income portfolios, could be a long-term problem. Experts say investors face a much more pressing concern: a shortage of the bonds themselves.
States and municipalities sold $295 billion worth of long-term bonds last year -- a big-sounding number, but nearly a third less than they issued in 2010, according to The Bond Buyer, a trade publication that tracks sales. And new bond issuance is down even more this year: states and municipalities issued nearly 2 percent less new, long-term debt in the first quarter of this year than they did during the same time last year. Local governments, worried about their existing finances, are putting off building new schools or other big-ticket projects. Fewer projects means fewer new municipal bonds, and investors are having a hard time finding any debt -- from anywhere to buy. Stan Richelson, who has built a financial-planning practice specializing in muni bonds, says it's the worst supply situation he's seen in his 25-year career.
The supply squeeze in the $3.7 trillion muni market is coming at a bad time for investors. Because Treasurys are paying historically low interest rates, people are looking for other types of investments that can deliver a steady source of income. Munis, historically, have had low rates of default, and their interest payments are often shielded from taxes; the lack of supply, though, is pushing prices on existing muni bonds higher and yields lower. In 2009 it wasn't tough to find a 20-year, AA-rated muni yielding 5 percent, Richelson says; today, such bonds yield about 3.5 percent. There aren't enough lower-quality "high yield" bonds to go around, either, says John Hallacy, head of municipal research at Bank of America Merrill Lynch.
Experts say investors determined to get munis can find them but that they might have to be a little less picky than usual. Hallacy suggests people consider a revenue bond, debt backed by revenue from a specific project (such as a sewer), rather than a so-called general obligation bond, which can draw its funding from anywhere. Revenue bonds are more plentiful, Hallacy says, and investors can find 20-year, A-rated revenue bonds yielding about 4.4 percent. Advisers say there's a flip side to the municipal bond shortage: "You can sell any bonds at a great price," Richelson says. To be sure, a seller will have a hard time finding an attractive new muni bond in which to reinvest the proceeds, but Richelson says it's worth doing the math to see if selling an existing bond might be more lucrative than just collecting the bond's regular interest payments.