What is going on with municipal bonds? The End of BABs (Build America Bonds) (from WSJ)

Muni Bonds Continue to Tumble
A Rush to Sell Build America Bonds Before They Are Gone.

By Romy Varghese and Kelly Nolan
Of DOW JONES NEWSWIRES

Prices of municipal bonds fell sharply for the second day Tuesday, driving yields on long-term bonds to the highest points in more than 18 months, as investors worried about the impact of the end of a federally subsidized borrowing program.

The yield on a closely watched index of high-grade, tax-exempt 30-year muni bonds rose to 4.84%, its highest level since March 2009, according to Thomson Reuters Municipal Market Data. The yield on 10-year bonds climbed to 3.24%, the highest since June 2009. Yields move inversely to prices.

.The market took a hit Monday as well, as the expiration of the Build America Bond program by the end of the year looked increasingly likely.

An extension of the program, which provides a 35% interest-rate subsidy from the federal government on taxable bonds issued by municipalities, on Monday wasn't included in legislation introduced in the U.S. Senate that continues Bush-era tax cuts.

Since the government started the BAB program in April 2009 as part of its economic stimulus, more than $165 billion of these bonds have been sold, accounting for about 22% of all new municipal debt, according to data from the U.S. Treasury Department.

Many municipal-bond market participants expect that, without BABs, state and local governments will issue more tax-exempt bonds next year and may overwhelm investor demand for that debt. This would force states and cities to raise their rates to attract buyers.

About $100 billion in long-term tax-exempt bonds would return to the market next year, estimated Robert Nelson, managing analyst at Municipal Market Data.

"With the loss of leveraged buyers of municipal bonds in 2008, there has been a dearth of demand for long maturity munis--this is where BABs came in and diverted this issuance to the taxable market," Nelson said. "Now without BABs the market is left to deal with the same supply/demand imbalance that plagued munis in 2008 and early 2009."

He added that long-term yields have generally returned to the same level seen at the outset of the Build America Bond program last year.

States with some of the lowest credit ratings have been especially battered by the recent muni-market turmoil.

The spreads on Illinois 10-year maturity general obligation bonds grew from 1.60 to 1.90 percentage points from Nov. 1 through Monday above a benchmark triple-A bond with the same maturity, according to Municipal Market Data.

Spreads on California general obligation bonds increased from 0.97 to 1.30 percentage points over the same time frame.

Meanwhile, municipal borrowers are plowing into the market with BAB deals in the last few market days of the year.

"We are hitting the market as quickly as we can because it's only going to get worse," said Harold Downs, treasurer of the Metropolitan Water Reclamation District of Greater Chicago.

Because of the market conditions, the water district is shrinking the size of its bond sale this week from $500 million to $280 million, he said. Most of the offering is BABs.

The Metropolitan Water District of Southern California is planning to sell $250 million in BABs this week, moving up part of a $450 million deal it had originally scheduled for the spring, said Brian Thomas, the water district's assistant general manager and chief financial officer.

"I think the market is still favorable if you look back over the last 10 years, but if you look compared to a month ago, it's a much more difficult market," Mr. Thomas said.

Higher yields may ultimately help stabilize the market by attracting buyers, said Dan Solender, director of municipal bond management at investment firm Lord Abbett in Jersey City.

And amid the volatility, some analysts are encouraging investors to buy municipal bonds from creditworthy issuers. Munis are now offering higher yields than U.S. Treasurys of comparable duration, which is the inverse of the usual relationship, noted Dan Loughran, senior portfolio manager at OppenheimerFunds. "Prices in the municipal bond market may continue to be volatile in the near term, but we believe relief is likely waiting in the wings once the New Year gets underway," he wrote in a report.

—Jeannette Neumann contributed to this article.
-By Romy Varghese, Dow Jones Newswires; 215-656-8263; romy.varghese@dowjones.com

Where to Find Higher Yield (Kiplingers Magazine)

Great rates in a low-yield world

BY Jeffrey R. Kosnett, Kiplinger's Personal Finance — 06/01/10

You're earning zilch on your savings. No sweat. We offer 18 investments that pay 5% or more.
A year ago you needed the nerves of a tightrope walker to buy any income security that didn't include the word Treasury in its name. Prices for just about everything else -- including corporate debt, real estate trusts and preferred stocks -- had been so pummeled that you could have been excused for thinking America was going out of business.

But, as we now know, this was a spectacular buying opportunity. Once credit markets thawed and investors gained confidence that a depression had been averted, just about every yield-oriented investment outside the comfort zone of Treasury bonds staged a rally for the ages. Over the past year, for example, junk-bond funds have gained nearly 50% on average, and the typical real estate fund has returned nearly 100%. Some preferred stocks of troubled banks have quintupled.

As a result of this remarkable rebound, high-income stocks, bonds and funds are no longer steals. But many still pay far more than the bupkis you get from money-market funds, and they outyield Treasury bonds, too. Plus, today you can buy high-yielding securities without assuming especially large risks. Continuation of a slow economic recovery should boost the fortunes of corporations and state and local governments without pushing up inflation, which would lead to higher interest rates in the bond markets -- and lower prices for many kinds of fixed-income securities (bond prices and interest rates move in opposite directions). Below, we list 18 investments that yield 5% or more, in ascending order of risk.

Taxable munis
In little more than a year, cities, states and public agencies have issued $100 billion of taxable Build America Bonds. BABs pay extraordinarily high interest rates because Uncle Sam, as part of the 2009 financial-rescue package, picks up 35% of the issuers' interest costs. BABs now yield more than corporate bonds with like maturities and credit ratings, making them great not just for IRAs and other tax-deferred accounts, but for taxable accounts as well.

Yields of at least 6% are common for new, long-term BABs. The state of Illinois, for example, just issued 25-year BABs at 6.6%. These are general-obligation bonds, backed by the state's taxing power. Standard & Poor's rates Illinois A-plus, although the state is on watch for a possible rating downgrade. If you prefer to lend to an entity that appears to be in better shape, consider a new, 30-year New York City water-and-sewer revenue bond. The BAB, rated double-A-plus, hit the market at 6.4%.

Fans of exchange-traded funds should consider PowerShares Build America Bond ETF (BAB , $25). With an average credit quality of double-A, it pays dividends once a month and yields 6.2% (all prices and yields are as of the April 9 close).

Preferred stocks
A preferred stock is closer in spirit to a bond than a common stock because a preferred dividend is almost always fixed. So if long-term interest rates rise, a preferred reacts like a bond and loses value. You also face company risk should the issuer run into trouble and suspend preferred dividends. If you can stand some price fluctuation, consider reinsurer Endurance Specialty Holdings 7.75% Preferred (ENH/PA , $24). Rated triple-B-minus, the issue is not callable until 2015 and sports a current yield of 8.1%. Under current federal law, the top tax rate on qualified dividends is just 15%. (Many stocks that look like preferreds are actually hybrid securities and aren't eligible for preferential tax treatment.)

Banks, insurers and real estate investment trusts are the most common issuers of preferreds. With a preferred-stock ETF, you can diversify into utilities and industrials. The oldest and largest among these is iShares U.S. Preferred Stock Index ETF (PFF , $39). It pays dividends monthly and yields 6.5%.

Juicy dividend payers
The overall U.S. stock market yields less than 2%, but you'll find plenty of profitable, blue-chip outfits that pay far more and are willing to maintain and even raise their disbursements. The best sources of fat dividends are utility, energy, drug and consumer-products companies. Should the economy start to weaken again, at least three of those sectors -- energy being the exception -- should hold up relatively well.

Shares of two telecommunications giants offer exceptionally generous yields. AT&T (T , $26) and Verizon (VZ , $30) recently yielded 6.4% and 6.3%, respectively. Although drug makers remain extremely profitable and have continued to pass out gobs of cash, their share prices have been stagnant for years, resulting in high yields. Our favorite for dividends: Eli Lilly (LLY , $37). Lilly has boosted its distribution 28 straight years, yet still pays out only half of its earnings. Its stock yields 5.3%.

Traded partnerships
Master limited partnerships are limited partnerships that trade on exchanges like stocks. MLPs pay no corporate taxes, so they can pay ample income to investors. On the downside, MLPs can add extra work when you prepare your taxes. Our favorite MLPs are those that own pipelines and energy terminals. They earn predictable fees and rents, rather than depend on the price of raw materials and refined fuels. Historically, these kinds of MLPs have yielded three to four percentage points more than Treasury bonds. That means they should yield 7% or higher today.

If you screen for MLPs that carry less debt than their peers yet still offer superior yields, two that stand out are Boardwalk Pipeline Partners (BWP , $30), which yields 6.7%, and Copano Energy (CPNO , $26), which yields 8.9%. Boardwalk owns three pipelines and 11 underground natural-gas storage fields; Copano operates gathering and transmission pipelines for gas producers in Louisiana, Oklahoma, Texas and the Rocky Mountains. An alternative to individual MLPs is Kayne Anderson MLP (KYN , $27), a closed-end fund that uses leverage (borrowed money) and has investments in 45 pipeline and storage MLPs (closed-end funds trade like stocks). Kayne Anderson recently yielded 7.1%, even though the shares traded at a 10% premium to the fund's net asset value. If you can buy the fund at a smaller premium -- or better yet, a discount -- pounce.

Treats With REITs
Beyond the fact that they were dirt-cheap near the end of the financial crisis, it's hard to explain why real estate investment trusts have performed so spectacularly. Most REITs own properties, such as office buildings, shopping centers, warehouses and posh mixed-use developments, that are hungry for buyers and tenants. Rents in many categories are flat or falling. REITs carry a lot of debt.

Still, you can find a few outliers that yield at least 5% and are reasonably safe. REITs that own health-care properties come to mind. Unlike offices and hotels, which are closely tied to the overall health of the economy, medical property is a growth business. And REITs own only 6% of U.S. health-related property, while they own 12% of all commercial real estate. So as health care assumes a greater share of the economy, medical REITs will have plenty of opportunities to build and buy. One of the best REITs in this sector is Health Care REIT (HCN , $46), which owns a wide range of facilities, including hospitals, nursing homes and medical-office buildings. It yields 6.0%. Another good choice is LTC Properties (LTC ), a much smaller REIT that owns nursing homes and assisted-living facilities in some 30 states and yields 5.5%.

Outside of health care, consider Realty Income (O ), a retail-property REIT that signs tenants to triple-net leases. These require clients to pay for property taxes, insurance and maintenance as well as rent. Realty Income has high occupancy and low debt, and it has paid monthly dividends for 40 years. It yields 5.4%.

One of a kind
Although it's set up as a REIT, Annaly (NLY , $17) owns no property. Rather, it borrows at short-term rates and invests the proceeds in medium- to long-term government-guaranteed mortgage securities. As long as the Federal Reserve holds short-term rates near 0% (1% would be okay), Annaly earns a bundle. And because it's a REIT, it must pay out at least 90% of its net income to shareholders. Over the past four quarters, it has paid $2.69 a share, which works out to a yield of 15.6% at the current stock price.

Normally a yield that high is a warning to stay away. But because Annaly's portfolio contains only government-backed securities, you needn't fear a rash of loan defaults. "This isn't glamorous or sexy," says Greg Merrill, a Seattle investment manager and a big fan of Annaly. "In fact, it's boring." Nothing wrong with that.

High-yield closed-ends
This category requires caution. Some high-paying closed-end funds aren't actually earning the amount they pay out (you can glean this sort of information from fund shareholder reports). Take a pass on those. However, others cover their high distributions with real earnings and income. If you invest at or below net asset value -- a wise idea when buying any closed-end -- you get good income at a fair price.

MFS Special Value Trust (MFV , $7) invests in an unusual combination: junk bonds and high-yielding stocks. It doesn't use leverage to enhance returns, but that doesn't mean it's a low-risk fund. It lost 35% on assets in 2008 and then gained 58% in 2009 (because investors become more enthusiastic about closed-ends in up markets and tend to unload them in down markets, the swings in performance based on share price were even more dramatic). The fund pays dividends every month from capital gains and interest income. It recently traded within a few cents of its NAV and is on track to distribute 69 cents a share this year. At the current price, that puts the yield at 9.5%.

Strategic Global Income (SGL , $11) has what's known as a managed-distribution policy. The fund, which doesn't use leverage, pays out 7% of NAV each month, using interest income and capital gains to cover the distributions. It's a go-anywhere bond fund, so the managers explore all sorts of investments, but their record has been decent over the past few years. The fund lost a modest 11% during the 2008 disaster, then staged a powerful 40% advance in 2009. The shares trade at a 10% discount to NAV, which explains why they yield 7.8% -- more than the distribution rate.


--------------------------------------------------------------------------------

All Contents © 2010 The Kiplinger Washington Editors

Slow & Steady Starting to Look Good - Municipal Bonds (from NY Times)

May 21, 2009
More Investors, Chastened by Stock Losses, Settle for Municipal Bonds
By PAUL SULLIVAN
THE historic lure of most municipal bonds has been their tax-free returns. But the recession and the rash of corporate troubles have widened their appeal to investors wary of the stock market who want to settle for a steady if unspectacular return.

Municipal bonds are still the terrain of high earners, who like their safety and higher tax-adjusted return than Treasury bonds. But increasingly average retail investors have been buying them to fill out their bond allocations. “Our average account has increased their asset allocation in fixed income to 52 percent and most of that is in munis,” said Robert Everett, director of fixed income at the Boston Private Bank and Trust Company. He said that was an increase of 15 percentage points from last year.

Even though the major stock markets have risen in the last month, uncertainty about the rally abounds. Suddenly, the return on a municipal bond of 6 to 7 percent, including the tax exemption, seems great.

The other draw has been safety. Historically, the default rate on investment-grade munis is less than a quarter of a percent, compared with almost 2 percent for corporate bonds. And the difference in yield between United States Treasuries and munis has recently been as much as 2.5 percent.

Given the pressure on city and state coffers, the default rate is likely to rise closer to 1 percent. But that is far lower than the yields on munis suggests, said George Strickland, a managing director at Thornburg Investment Management of Santa Fe, N.M. “The market thinks 20 percent of investment grade issuers will default in the next 10 years,” he said. “The major muni issuers are doing well.”

Being selective with munis is key. The first risk investors need to understand is the difference between general obligation and revenue bonds. General obligation bonds are sold to finance the daily operations of a municipality. Legally, that entity is obligated to do whatever it needs — from cutting services to raising taxes — to make its bond payments.

A revenue bond is sold to finance particular projects like hospitals, utilities and stadiums. The receipts from such projects are used to make the bond payments, and many investors have started to wonder how these will hold up.
“Stay away from revenue bonds, backed by projects like a parking lot at a university,” warned Gregg S. Fisher, chief investment officer of Gerstein Fisher, an investment advisory firm in New York. “If cars stop showing up, then you could have trouble getting your money.”

Hospital bonds also need to be evaluated carefully. “Community hospitals with A and BBB ratings are feeling the pinch because people without insurance go to them and can’t pay,” said Ronald J. Sanchez, director of fixed income strategies at Fiduciary Trust, a unit of Franklin Templeton Investments. “You need to avoid certain segments with greater risk.”

This points to another issue: liquidity. Roughly $360 billion of new bonds are sold annually. New York and California are the benchmark issuers and their bonds are traded often. But there are scores of municipalities that sell bonds that buyers may have to hold for their duration because of illiquid markets.

Munis are traded in an over-the-counter fashion, which means finding a price quote, let alone a buyer, can be difficult at times. Although small investors make up a good part of this market, the Securities and Exchange Commission has no role in its regulation.

But for those aware of the risk, there are investing opportunities. During the first quarter, few municipalities sold bonds because they were waiting to see what the stimulus plan would bring them. Now, cities and states are making up for lost time.

Several portfolio managers advise that shorter-dated munis are safer. “The longer the duration the more volatility,” said Mr. Strickland, who likes the two- to three-year range.

Diversification is also being pushed for munis. Historically investors have concentrated on bonds from their state to get the full tax deduction. But owning bonds from other states could give them a greater return, as in the case of California, where a fiscal crisis has pushed up yields.

The recession has brought about new securities, known as Build America Bonds, to help ailing municipalities raise money. They allow municipalities to sell taxable bonds for capital projects while receiving a rebate from the federal government for a portion of their borrowing costs. The program is meant to attract institutional investors who typically do not buy munis. But they could also suit a retail investor who wants to put them in a taxable retirement account.

US Treasury on Buy America Bonds (BAB)

April 3, 2009 - US Treasury Press Release
TG-81

Build America Bonds and School Bonds
Investing in our States, Investing in our Workers, Investing in our Kids

The United States is facing the most severe financial crisis in generations. Extraordinary challenges require extraordinary action by our government to ensure the economy gets back on track and that millions of Americans get back to work. The American Recovery and Reinvestment Act of 2009, along with the Financial Stability Plan, are critical steps. In just two months, the Obama Administration, in conjunction with Congress, has enacted legislation to create or save 3.5 million jobs; give a tax break to 95% of working families; and has put forward detailed programs to address falling home prices, frozen credit markets, weak bank balance sheets and legacy assets.

Creating the conditions for an economic recovery also requires addressing the challenges facing state and local governments in the midst of the current economic climate. Budgets are being scaled back, government jobs are being cut, and services are being curtailed. These cuts contribute to a deeper recession, while restricting access to services at a time when the need for them is greatest. Turning things around requires innovative thinking.

Today Treasury announces two new, innovative bond programs to help states pursue capital projects. This funding means much needed infrastructure projects can begin to revitalize our communities while putting Americans back to work.

BUILD AMERICA BONDS
First, Treasury announces the implementation of the Build America Bond program under the American Recovery and Reinvestment Act of 2009 to provide much-needed funding for state and local governments at lower borrowing costs. This will enable them to pursue necessary capital projects, such as work on public buildings, courthouses, schools, roads, transportation infrastructure, government hospitals, public safety facilities and equipment, water and sewer projects, environmental projects, energy projects, governmental housing projects and public utilities.

Traditionally, tax-exempt bonds provide a critical source of capital for state and local governments, but the recession has sharply reduced their ability to finance new projects. Supplementing this existing market, the Build America Bond program is designed to provide a federal subsidy for a larger portion of the borrowing costs of state and local governments than traditional tax-exempt bonds in order to stimulate the economy and encourage investments in capital projects in 2009 and 2010.
HOW BUILD AMERICA BONDS WORK
Build America Bonds are a new financing tool for state and local governments. The bonds, which allow a new direct federal payment subsidy, are taxable bonds issued by state and local governments that will give them access to the conventional corporate debt markets. At the election of the state and local governments, the Treasury Department will make a direct payment to the state or local governmental issuer in an amount equal to 35 percent of the interest payment on the Build America Bonds. As a result of this federal subsidy payment, state and local governments will have lower net borrowing costs and be able to reach more sources of borrowing than with more traditional tax-exempt or tax credit bonds. For example, if a state or local government were to issue Build America Bonds at a 10 percent taxable interest rate, the Treasury Department would make a payment directly to the government of 3.5 percent of that interest, and the government's net borrowing cost would thus be only 6.5 percent on a bond that actually pays 10 percent interest.

This feature will make Build America Bonds attractive to a broader group of investors, and therefore create a larger market than typically invest in more traditional state and local tax-exempt bonds, where interest rates, due to the federal tax exemption, have historically been about 20 percent lower than taxable interest rates. They should be attractive to investors without regard to their tax status or income tax bracket (e.g., pension funds and other tax-exempt investors, investors in low tax brackets, and foreign investors).

GUIDANCE TO STATES ON BUILD AMERICA BONDS
The IRS is releasing Notice 2009-26 to provide state and local governments with prompt guidance on implementation of the new direct federal subsidy payment procedures for Build America Bonds so that issuers can begin issuing these bonds with confidence about how these federal payments will be made. This guidance covers the direct federal subsidy payment procedures regarding:

how (on new IRS Form 8038-CP available now) and when (by 45 days before an interest payment date) to request these payments;
when the IRS will begin making these payments (July 1, 2009);
how to make necessary elections to issue these bonds (in writing in an issuer's books and records);
how to satisfy the information reporting requirement for these bonds (modified IRS Form 8038-G); and
future implementation plans (electronic platform in 2010).
Finally, the Notice solicits public comments on all of the plans for this program.

SCHOOL BONDS
In addition, Treasury also announces today guidance on allocations of national bond volume cap authorizations for two innovative tax credit bond programs for schools, known as Qualified School Construction Bonds and Qualified Zone Academy Bonds. The American Recovery and Reinvestment Act of 2009 provided new or expanded authorizations, respectively, for these two programs. These tax credit bond programs allow state and local governments to finance public school construction projects and other eligible costs for public schools with interest-free borrowings. These tax credit bond programs provide this federal subsidy by giving those who buy these bonds a federal tax credit that essentially allows state and local governments to issue these bonds without interest cost.

The guidance that Treasury is issuing today allocates the national bond volume authority for these school bond programs among the states and certain large local school districts pursuant to statutory formulas. These volume cap allocations are important to enable State and local governments to use these low-cost borrowing programs to finance school projects to promote economic recovery and job creation.

For Qualified School Construction Bonds, the guidance divides the $11 billion national bond volume authorization for 2009 among the states and 100 largest local school districts based on Federal school funding.

For Qualified Zone Academy Bonds, the guidance divides the $1.4 billion bond national bond volume authorizations for each of 2008 and 2009 among the states based on poverty levels.

MARKETWATCH California BABS Build America Bonds

California sells $6.85 bln in infrastructure bonds

By Laura Mandaro
Last update: 2:12 p.m. EDT April 22, 2009
SAN FRANCISCO (MarketWatch) -- California sold $6.85 billion in general obligation bonds Wednesday, including $5.23 billion in federally subsidized Build America Bonds, its state treasurer's office said Wednesday. The bond sale was expanded from original plans of about $3 billion, and the Build America portion is the largest under that federal program to date. All of the bonds in the deal were taxable, a change from most municipal issues. The U.S. is subsidizing interest payments on the Build America Bonds to help states sell taxable infrastructure bonds to a different group of investors without paying more interest. With the subsidy, the Build America Bonds carry a rate of 4.83%. All are in 25-year and 30-year maturities.