Muni bonds gain as high yields finally lure buyers

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The municipal bond market showed more signs of strength on Wednesday as some bargain-hunters apparently came off the sidelines, lured by the surge in tax-free yields since late October.

The annualized tax-free yield on the Bond Buyer index of 40 long-term muni bonds nationwide fell for the first time since Dec. 20, easing to 5.92% from a two-year high of 5.95% on Tuesday.

Bond yields fall as prices of the securities rise. A modest rally in muni bond prices Wednesday showed up in the share values of some popular muni mutual funds.

Shares of the BlackRock National Municipal fund rose 4 cents, or 0.4%, to $9.52, the first increase since Dec. 29. The Vanguard California Long-Term Tax-Exempt fund edged up 2 cents, or 0.2%, to $10.42 after slumping 3% in the previous nine sessions.

The muni market has been hammered over the last three months, first as part of a sell-off in bonds in general in November, then by worries about the budget woes facing many deficit-ridden states and municipalities.

Wall Street banking analyst Meredith Whitney badly spooked investors in late December with her prediction that muni bond defaults would surge in 2011. Whitney has been savaged by many veteran muni bond fund managers who say her forecast is ridiculously overblown, and that the vast majority of local governments would make good on their debt payments.

But some state and local officials have helped undercut their own bond market. New Jersey Gov. Chris Christie warned last week that healthcare expenses for public workers “will bankrupt” the state if those costs aren’t reined in.

On Wednesday, Los Angeles Mayor Antonio Villaraigosa said at the U.S. Conference of Mayors meeting that there was “no question you’ll see some cities in default,” although he insisted that there was “no scenario where we [L.A.] would ever be in the ‘B’ situation,” referring to bankruptcy.

Meanwhile, Vallejo, Calif. -- one of the relative handful of cities now in bankruptcy (it filed in 2008) -- on Wednesday offered a workout plan that would pay unsecured creditors 5% to 20% of what they’re owed.

Despite the likelihood of more turmoil in the muni market in the months ahead, muni advocates say investors are being well-rewarded for the risks -- with tax-free bond yields now nearing or exceeding yields on taxable bonds.

John Wiley, co-manager of the Franklin California Tax-Free Income fund, said that munis overall would remain “the second-safest asset class besides U.S. Treasuries.”

“If you’re not forced to sell, you shouldn’t,” Wiley said.

-- Tom Petruno