US - Tax Sales Threaten To Extend Worst Losses Since ’08: Muni Credit
13 November 2013
Posted by: Author: Brian Chappatta
Author: Brian Chappatta (Bloomberg)
Buying municipal bonds usually helps
individuals lower taxes. This year, amid the worst losses in the
$3.7 trillion market since 2008, so does selling the debt.
While the Standard & Poor’s 500 (SPX) index of stocks has risen
about 24 percent this year, city and state securities have
dropped 2.5 percent, S&P data show. It would be the first time
since 1999 that the equities gauge has climbed while munis fell.
Investors looking to minimize 2013 federal capital-gains taxes
can sell local debt or muni mutual funds and take a loss to
offset equity profits.
The higher tax rates Congress passed this year have some
top earners seeking ways to lower costs. That could spur further
muni losses in the final weeks of 2013 as selling converges with
the typical year-end trading lull, said Chris Ryon at Thornburg
Investment Management. The market has gained from Nov. 1 through
year-end in 10 of the past 14 years, S&P data show.
The market may "get a big flood of money out of municipal-bond mutual funds, which could add to volatility at the end of
the year,” said Ryon, who helps oversee $10 billion of munis
from Santa Fe, New Mexico. "The question is if they go back
into the mutual funds right away, or if they sit on the
sidelines for a while.” Turbo Taxes
The top tax rate on long-term capital gains and dividends
rose to 20 percent from 15 percent on Jan. 1, and President
Barack Obama’s health-care law added an extra 3.8 percent levy
on such income for high earners. Investors looking to reduce the
payments while also maintaining municipal-bond holdings can
execute what is known as a tax swap. That involves selling debt
for a loss and purchasing what the Internal Revenue Service
deems a substantially different security.
Most municipal-debt interest is exempt from federal, state
and local levies and even the Affordable Care Act surtax, which
makes it attractive for higher earners. Holders still pay
capital gains on any price appreciation if they sell the bonds.
Congress set the top tax rate for income above $450,000 for
married couples or $400,000 for individuals, after deductions.
Those are the same thresholds for the top levy on long-term
capital gains and dividends.
Individual investors own about 70 percent of local-government bonds either directly or through mutual funds,
Federal Reserve data show. Island Prices
Investors who hold Puerto Rico bonds or one of the 77
percent of muni mutual funds that own the commonwealth’s debt
may face the biggest losses. The island’s securities have
declined 15.6 percent this year, S&P data show.
Another round of selling would add to a record exodus from
muni mutual funds. Individuals have already pulled about $48
billion from the portfolios in the first 10 months of the year,
a reversal from the $44 billion inflow over the same period in
2012, Lipper US Fund Flows data show.
Tax-exempt debt has still gained in back-to-back months for
the first time since February as Federal Reserve Chairman Ben S. Bernanke refrains from reducing the central bank’s bond-buying
program. Benchmark yields, which move inversely to prices, set a
four-month low on Oct. 31.
Because of the rally, now may be the best time for a tax
swap rather than waiting for the year-end deadline, Vikram Rai,
a fixed-income strategist at Citigroup Inc. in New York, said in
an interview. On Holiday
The difference between what buyers are willing to pay and
what sellers demand "will be wider in December because of low
liquidity,” he said. "It could add to weakness in the
Trading tends to decline in November and December, which
include market holidays for Thanksgiving and Christmas.
In 2012, institutional bondholders such as mutual funds put
an average of about $1 billion of munis up for sale each day in
the week through Dec. 21, data compiled by Bloomberg show. The
following week, which included Christmas, the average sank to
"Clients who give their bond portfolio manager plenty of
notice tend to benefit from more efficient execution of tax-loss
swaps,” said Justin Land, who helps manage $3 billion of munis
at Wasmer Schroeder & Co. in Naples, Florida. He said he’s been
looking at opportunities for such a move since July because
"December could get messy.” Double-Digit
Investors whose capital losses exceed gains can also deduct
the declines against ordinary income by as much as $3,000 and
carry any unused portion forward to offset future returns, Phil Fischer, head of muni research at Bank of America Merrill Lynch,
said in a report.
The IRS’s wash-sale rule prohibits individuals from
recognizing a loss when selling a security if they purchase the
same one within 30 days. Investors can work around that
restriction if they switch within the same locality, such as
trading Charlotte, North Carolina, water-revenue bonds for the
city’s general obligations, Land said. Both have AAA ratings
Swapping will help balance buyers and sellers in the final
months of the year, rather than the period being skewed toward
investors looking to offload munis, said John Bonnell, who helps
oversee $20 billion of local debt at USAA Investment Management
Co. in San Antonio.
"December is going to be pretty noisy and pretty busy this
year,” said George Friedlander, Citigroup’s chief muni
strategist in New York. "The losses are there, and people want
to take some gains on the equity side.” Market Week
Issuers nationwide are offering about $5.3 billion in long-term debt this week with benchmark yields at the highest since
Top-rated 10-year munis yield 2.76 percent, compared with
2.77 percent on similar-maturity Treasuries.
The ratio of the interest rates, a measure of relative
value, is about 99.6 percent. It fell below 100 percent on Nov.
8 for the first time since June. The smaller the number, the
more expensive munis are compared with federal securities.
Following is a pending sale:
Baltimore plans to offer about $582 million of revenue
bonds to pay for water and sewer projects and refinance related
debt next week. Some proceeds will be used to terminate
interest-rate swaps tied to auction-rate debt, offering
This article first appeared in bloomberg.com.