Wanna see something really scary?
Got munis? Hope not...
This is S&L deja vu all over again.
Events at Heartland Are Only the Beginning: Joe Mysak
New York, Oct. 25 (Bloomberg) -- The collapse of two high- yield municipal bond funds comes as a surprise only to the naive.
Heartland Advisors, of Milwaukee, last week told investors that an internal pricing committee decided to cut the value of its High-Yield Municipal Bond Fund by 70 percent, and its High Yield Short Duration Muni Fund by 55 percent.
That means investors in the high yield fund found that their shares were worth $2.45 instead of $8.01. Those who held shares of the short duration fund found that their shares were worth $4.87 rather than $8.70.
Can such things be? Municipal bonds are synonymous with income, safety, and preservation of capital. Their default rates are infinitesimally low. What's going on here?
Heartland says it normally relies on independent pricing services to determine the values of the funds. ``Because of a current lack of liquidity in the high-yield municipal bond markets generally, and because of credit quality concerns and a lack of market makers,'' Heartland took it upon itself to consider other things besides the best-guess prices provided by the services, according to an Oct. 16 addendum to the prospectus for the funds.
And then? And then Heartland marked the funds down to reflect the prices they might get on the bonds if they had to sell them to satisfy redemptions.
That is the story specific to the Heartland funds. The real story is, it's not limited to the Heartland funds.
The Go-Go Years
The real story is that all during the 1990s, municipalities from coast to coast sold more and more bonds designed to boost economic development.
They sold bonds for nursing homes, for-profit prisons, stadiums, golf courses, theme parks, housing developments in the desert, factories of all description, aquariums, racetracks, museums, convention centers, hotels, and mills designed to take one thing and turn it into something else.
In most cases, the bonds were not backed by the municipal coffers, but were to be repaid entirely from the money generated by the projects. In other cases, municipalities overcame whatever inhibitions they may have had against getting into businesses where the private sector failed to tread, and borrowed the money and built the projects themselves.
These were very different types of municipal bonds, in other words. They really were loans to small, and in some cases nuttily speculative, businesses. Still, they were called municipal bonds.
Step Right Up
The municipal market, in effect, took the place of the savings and loan associations of the 1980s. The market made risky loans, and it did so cheaply. Interest rates declined in the 1990s, to levels not seen in decades. Buyers accept even lower yields from muni bonds because they are exempt from taxes.
While all this was happening -- more nutty transactions, interest rates declining -- the municipal market, like the rest of the financial world, saw the rise of the professional money manager. At the beginning of the 1980s, only 10 percent of the muni bonds outstanding were under the control of bank trust officers or mutual fund managers. Today, about half are.
In 1984, there were 48 municipal bond mutual funds, according to Lipper Analytical Services; there are now more than 250. In 1984, three municipal bond funds specialized in high yield debt. Today there are more than 50.
More and more buyers vied for high-yield municipal bonds. What happened next was predictable. Credit spreads contracted. In 1982, the spread between top-rated bonds and those rated by Moody's Investors Service as ``Baa,'' which is still investment grade, was 150 basis points. That spread fell to 55 basis points by the beginning of the 1990s.
Priced to Perfection
``High-yield'' got to mean less and less. By the end of the 1990s, unrated, speculative transactions offered returns not in the 10 percent or higher range, but in the 7 percent range, and sometimes even in the 6s, while yields on higher-rated bonds were in the 5 percent range. On Aug. 31, Heartland advertised a 6.85 percent yield for the ``high yield'' fund.
As the 1990s went on, the pace got faster. The guys running the high-yield funds bought nuttier and nuttier bonds, and got less and less reward for the risk. And why not? If you own two or three bonds, and one goes bad, that's disastrous. If you own dozens of different bonds, you can afford a few bombs.
What's going to happen next is tough to say. Hundreds of the transactions sold in the latter 1990s were priced to perfection. That is, they were sold during boom times, and based on the most optimistic projections contained in feasibility studies. Some have already blown up; more will, economic soft-landing or not. Most of them are in high-yield muni funds.
Fitch Investors Service, which rates municipal bonds, put things in perspective last year when it reported that not all bonds were created equal. Some munis have a default rate under 1 percent. On others, the default rate is closer to 20 percent. This was a revelation.
Conlin Speaks
Which brings us back to Heartland. Heartland is not saying precisely why it cut the value of one of its funds by 70 percent, which is unprecedented.
Heartland's not talking. Tom Conlin, who used to manage the funds, is. Yesterday, he sent a letter to reporters who have covered the Heartland story since it broke on Sept. 28, which was when the company said Conlin quit, and that it was also reassessing the value of the bonds in its funds.
Conlin says he started ``exploring other business opportunities'' back in July, and gave Heartland his two-week notice on Aug. 17. The firm asked him to stay on until Sept. 30. ``I do not know why Heartland management determined to announce my resignation at the close of business on September 28, after the net asset values of the funds had been adjusted downward, reflecting their first significant decline,'' said Conlin.
In a telephone interview, Conlin said he was ``baffled'' by the 70 percent cut. ``Any high-yield fund has some problems,'' he replied, when asked if the fund was loaded with losers. Some of the bonds might have had to be repriced, but for the entire fund to be marked down 70 percent in value, ``I find it hard to justify,'' he said.
By the way, Conlin said he plans to continue working in the financial services industry, but not as a manager of high-yield municipal funds.
Oct/25/2000 15:24 ET
For more stories from Bloomberg News, click here.
(C) Copyright 2000 Bloomberg L.P. |
