Muni Bonds Outpace Other Bonds in 1993 In After-Tax Return

THE year 1994 is already shaping up as another banner one for municipal bonds.

Spurred by higher taxes on the wealthy, plus a slight lessening of supply of new bond issues, municipal bonds are expected to once again outpace the overall bond market in total after-tax return and in percentage increase in sales.

``1993 was a very strong year for municipal bond sales,'' says Jeffrey Kratz, a vice president with John Nuveen & Company, an investment house in Chicago. ``We expect 1994 to also be very good.'' Last year Nuveen's total sales of municipal bonds were $6.5 billion, slightly below the $7 billion in sales for 1992.

Last week's modest increase in short-term rates by the Federal Reserve Board is not expected to diminish the attractiveness of municipal bond issues relative to other bonds, such as long-term treasury bonds, Mr. Kratz says.

Last Friday the Fed nudged short-term rates up slightly by boosting the federal funds rate from 3 percent to 3.25 percent. The price of 30-year United States Treasury bond issues fell slightly, while bond yields rose from 6.31 percent last Thursday to 6.33 percent on Friday. Bond prices and bond yields move in opposite directions.

Currently, more than $1.1 trillion worth of municipal bonds are outstanding in the US. After the enactment of tax reform legislation in the 1970s, municipal bonds survived as one of the few remaining tax shelters for the well-to-do, as well as the middle class. Municipal bond issues generally pay higher interest rates than US government bonds. And interest earnings are typically exempt from federal and some state and local taxes. The total return on municipal bonds for 1993 on average was about 13.5 percent.

Municipal bonds are issued by states, cities, and other state or municipal public agencies. Last year, about $290 billion worth of bonds were issued, up from a record high of $232 billion in 1992, Kratz says. But because of fiscal belt tightening at the local government level, the total volume of new bonds is expected to drop off somewhat this year, he adds. That lessening of supply should help bolster bond prices.

Mutual fund purchases were responsible for much of last year's activity in municipal bonds. Total sales of municipal bond funds, including reinvested dividends, soared to $74 billion in 1993, up from $55 billion in 1992, according to Betty Hart, a spokeswoman for the Investment Company Institute, a trade group in Washington. Excluding redemptions, net sales totaled $46 billion in 1993, compared with $34 billion in 1992.

Net sales of municipal bond funds far outpaced the sales of all other bond funds. Net sales of all bond funds reached $139 billion in 1939, compared with $115 billion in 1992.

One question mark facing ``muni bonds'' is the impact of prospective new federal regulations in the marketing of bonds. Last September and October, a US House of Representatives subcommittee held hearings into alleged misdeeds and corruption in the muni-bond market. But no formal legislation ``has yet emerged,'' according to a committee spokeswoman. New laws, if they are to be enacted, are ``months away,'' she says.

Last year, scandals involving municipal bond transactions occurred in at least three states: New York, New Jersey, and Massachusetts. The most common occurrence related to financial contributions from bond underwriters to the politicians issuing the bonds. There has also been criticism within the secondary bond market (where outstanding bonds are traded) about the lack of detailed and timely information regarding the financial well-being of municipalities issuing bonds.

``It is our position that the more detailed information the public has about ... municipal bonds, the better for the industry as well as the public,'' says the ICA's Ms. Hart. ``More people will feel comfortable about acquiring municipal bonds.''