Munis Get Their Due

Heidi Hukriede and Dennis Hippen co-manage about $480 million in municipal bonds for Stonebridge Capital Advisors, LLC, in St. Paul. Compared to, say, corporate bonds and bonds backed by home mortgages, municipal bonds represent a more prosaic land of debt, but they do finance our roads, sewers, bridges, prisons, and a whole bunch of other stuff.

Hukriede and Hippen spend their days plowing through the countless offerings of debt in fiber optic cable systems, alternative energy facilities, and other issues, most of them without credit ratings—so their picks are exclusively tied to their own research. That makes for some heavy lifting occasionally, but the right choices can bring healthy results.

{Q} Has the municipal bond market reacted to the trend of higher interest rates?

{Hukriede} It has. Yields are up slightly on rated paper. Spreads—namely the prices you pay for lower-rated bonds—are slightly narrower [as of late July]. As the economy has gotten stronger, those spreads have compressed because the risk of buying lower-rated bonds has become less pronounced.

{Q} Haven’t spreads expanded among some bonds?

{Hippen} A lot of that is the result of the economics of certain sectors, such as the housing market. Certain sectors in the economy on the corporate side aren’t doing as well in the economic rebound as others.

{Q} And that’s not the case for municipal bonds?

{Hukriede} On the municipal side, there has been a high demand for yield. Even though yields on AAA bonds, which of course are the highest rated and have the lowest perceived risk, are rising somewhat, they’re still quite low—3.5 percent to 4 percent.

{Hippen} Remember, when the Fed was reducing interest rates, rates in the municipal bond market, especially on the longer maturity bonds, did not decline nearly as much as we anticipated. They were—and tend to be in general—somewhat contra-cyclical in that sense. This market moves a little bit in tune with its own dynamics, which are primarily tied to demand for the product.

{Hukriede} And the municipal curve also stays steeper. When the Treasury curve went inverted, the municipal curve never even got close to going flat or inverted. It was flatter than historically, but it maintained a certain amount of steepness.

{Q} Are these bonds generally a better deal than, say, a comparable corporate bond, where you have to pay taxes on the interest you earn?

{Hukriede} Yes. For example, a 4.75 single-A-rated, long-term, tax-exempt bond would be the taxable equivalent of 7.3 percent at the 35 percent tax bracket.

{Q} Hence the demand?

{Hippen} Yes. And that has been the case for quite a long time. Marginal rates have come down somewhat in the past seven or eight years, but not enough to overwhelm this dynamic.