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By Mike Taggart, CFA | 02-15-2012 03:00 PM

Nuveen: Muni Credit Risk Is Overblown

Improving local-government finances and lower default rates than corporates have made high-yield municipal bonds an attractive option for investors eyeing tax-free income, says Nuveen's John Miller.

Mike Taggart: Hi, I'm Mike Taggart, director of U.S. closed-end fund research at Morningstar. With me today is John Miller, co-head of fixed income at Nuveen Asset Management. John, thanks for joining me.

John Miller: Thank you for having me.

Taggart: Many investors like municipal bonds because they like the tax-free income that comes from investing in municipal bonds. What areas of the municipal market have been doing well lately?

Miller: Well, there has been a tremendous snapback from the pressures of a year ago when municipal bonds were of great concern due to fiscal stresses. The strongest segments of the market have really been shorter- to intermediate-term bonds and bonds with credit ratings in the A, A+ category into AAs and AAAs. So the highest-quality bonds and short- to intermediate-term bonds have been the strongest, most liquid, and most in-demand.

Taggart: And a lot of those are trading at premium right now, so investors are paying above par value for those.

Miller: Correct. A lot of large segments of the municipal market have 5% coupons, and 5% coupon bonds in the intermediate part of the yield curve can oftentimes only yield between, say, 1% and 2% in total yield. So that drives the bond price to a high premium.

Taggart: So really for that sector, that segment of bonds that's done really well lately, right now it's not offering a lot of income. But it seems to be offering a lot of, maybe, stability, or how would you characterize that?

Miller: Demand is strong, and that keeps the bonds very liquid. They have not been particularly volatile. They do offer higher yields than U.S. Treasuries, for example, and obviously, they are tax-free. So, it's mostly preservation of capital with some tax-free income even though that level of tax-free income has been driven down to, say, 1%-2% for that type of muni bond.

Taggart: Well, right now given that, for income-oriented investors who don't want to pay taxes on their income, are there any sectors right now that look good?

Miller: Yes. There are couple of segments in the municipal-bond market that have also started to improve but have lagged the broader market a little bit and still offer yields depending on the specifics in the 5.75% to 6.75%, and in some cases, 7% range. Specifically, those would be high-yield municipal bonds, BBB, non-rated, below-investment-grade-rated municipal bonds.

Taggart: So, a lot of credit risk?

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