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By Jeremy Glaser | 02-17-2011 11:40 AM

What to Approach, What to Avoid in Munis

Morningstar bond strategist Dave Sekera comments on recent trends, opportunities, and red flags in the muni market today.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

I'm joined today by Dave Sekera. He's a bond strategist here at Morningstar, and he is here to take a look at how outflows from muni bond funds have impacted the municipal market and if it's created any opportunities for individual investors.

Dave, thanks for joining me today.

Dave Sekera: You're welcome. Good to be here.

Glaser: Could we start off with just a general overview of the muni market? How big is this market, how many issuers are there, what are some of the key facts people should be aware of?

Sekera: Sure. One thing about the municipal market that I think a lot of people don't realize is just the size of the market. It is about $3 trillion in debt outstanding across all of the different municipalities in the United States, and there are just tens of thousands of different individual municipal issuers out there, most of which probably have less than $100 million of debt outstanding.

So when we compare it to the size of the corporate bond market, it is smaller in a nominal amount, but the corporate bond markets only probably has several thousand issuers outstanding. Those individual issuers typically have a larger amount of debt outstanding each.

Glaser: So that's pretty different from corporate bond markets.

Sekera: Right, and so that's part of the dynamics that we're seeing going on right now, so in the corporate bond market, as an analyst, I can cover 50 or 60 different credits, whereas in municipal bond market there are just so much more individual credits outstanding, and you need to do the same kind of due diligence on it. I think that's causing some of the technicals we're seeing in the market right now, as they just aren't enough buyers out there to handle all the volume of supply that is coming out.

Glaser: So certainly with fallen prices we've seen over the past couple of months in munis, and some hand ringing about defaults, and [fears] that there are going to be mass defaults. What does that look like in terms of the credit quality of munis for the last couple of years?

Sekera: In the last couple of years, we definitely have seen tax revenues across the board go down, and that has impacted their cash flows and has impacted their credit metrics.

However I would say, based on their own internal GDP forecast for this year, Bob Johnson, our director of economic analysis, is looking for 4% GDP growth, and that should help balance the revenues that are coming in, and in fact we have seen some slight increases in tax revenues coming in.

Glaser: Even before these more tax revenues, were we seeing a huge wave of defaults in the municipal space?

Sekera: No, we weren't seeing a huge wave of default, and in fact I've got some statistics here for you. So reportedly over the last 39 years, there have only been 54 bond defaults in the municipal bond market. Three quarters of those defaults have really been concentrated in the stand-alone housing bonds and some of the health-care bonds out there, and really only a few of them were general obligation bonds.

Glaser: So it sounds like defaults haven't been a huge problem, that revenues are going up. Why is there so much concern in the marketplace, then? Why do we hear so much from individual investors and from others that the municipal market is really in trouble?

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