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Municipal Buys Abound, Some Analysts Say

June 21, 1986

NEW YORK (AP) _ The tax-exempt bond market now offers some attractive buys for investors willing to put up with the ups and downs that are bound to occur as tax reform unfolds in Congress, analysts say.

Uncertainty over the pending tax law changes has been holding back municipal bond prices all year.

Over the same time, the prices of Treasury issues have pushed ahead coinciding with the sharp decline in market interest rates.

The result is that many municipal bonds currently carry higher returns than those on Treasury securities, which are subject to federal tax.

″There is a value for virtually everyone in every tax bracket and that’s not going to go away when the tax bill passes,″ said Jeffrey Noss, vice president and manager of municipal research for Roosevelt & Cross Inc. in New York. ″We’re looking at the highest returns relative to Treasuries that we’ve seen probably in the last 20 years.″

Some long-term municipals now yield about 8 1/2 percent while 30-year Treasury bonds have recently been yielding 7 1/2 percent to 7 3/4 percent. That is a rare occurrence since, historically, yields on tax-exempt issues have been 20 percent to 30 percent lower than Treasury paper of comparable maturity.

Robert Fagan, a senior vice president and manager of the municipal bond department at Thomson McKinnon Securities Inc. in New York, points out that prices of municipals will eventually catch up with Treasuries. But, for the time being, he says, ″There’s no question that there are some good buys.″

There are already signs that investors are being drawn back to municipals.

This past week tax-exempt bond prices rose strongly. According to the Bond Buyer’s municipal barometers, yields plunged 24 to 36 basis points over the last five trading sessions. A basis point is a hundredth of a percentage point.

The improvement came in part because market players feel less threatened by the tax reform legislation working its way through the Senate than they did by the version passed by the House late last year.

″The municipal market can live with it and thrive,″ said Noss of Roosevelt & Cross, referring to the sweeping tax bill drafted by the Senate Finance Committee. The full Senate is scheduled to take a final vote on the bill Tuesday.

Analysis of the Senate proposals done by the Public Securities Association, the industry’s trade group, indicates that the House bill could sharply curtail municipal bond market liquidity. Volume by 1991 could shrink to a level below that of 1982, the group estimates.

Under the Senate bill, the setback in new municipal issues would be far less severe, the association said.

Nonetheless, some observers still see tough times ahead for the municipal bond business.

″I’m still a little pessimistic,″ said William Gross, a managing director of Pacific Investment Management Inc. in Newport Beach, Calif. ″There’s more selling to come,″ he predicts, and that means prices could be depressed anew.

Gross, who is now advising clients to choose Treasuries over municipals, sees at least two dark clouds hovering over the tax-exempt market.

First, he fears further negative fall-out from tax reform. ″When you get such a blockbuster event, as tax reform will be, the impact will carry on for several months.″

There is no guarantee, he notes, that Congressional negotiators will not include objectionable portions of the House tax bill in the final draft.

Gross is also concerned about the possibility of refundings. In a time of falling interest rates, issuers sometimes favor calling back expensive outstanding debt.

Many municipal bonds available on the market provide only five to 10 years of call protection, meaning the issuer is barred from refunding until five to 10 years have elapsed since the bond was issued.

The market could also find itself struggling under the weight of heavy volume this summer, as many issuers are expected to bring bonds to market before the possible tax restrictions take effect.

Still others, such as George D. Friedlander, an analyst with Smith Barney, Harris Upham & Co. Inc. in New York, offer more bullish assessments.

″Given the extreme shortage of ways to reduce or defer taxes which will exist in the post-tax reform environment, it is likely that municipal bonds will be the investment of choice for a large number of retail investors, even at yield ratios substantially below current levels,″ Friedlander said.

″As a result, municipal bonds have the potential to greatly outperform taxable investments over the next three to six months.″

End Adv Weekend Editions June 21-22

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