Investors continue to stuff cash into municipal bond mutual funds, exacerbating a supply-demand imbalance that has kept yields on tax-exempt bonds near historic lows.
Municipal funds that report their figures weekly posted a net inflow of $760.6 million during the week ended Sept. 1, according to Lipper FMI. Weekly inflows have been positive nine straight weeks now. Investors have withdrawn money from municipal funds in only three weeks since the beginning of 2009.
All municipal funds, including those that report their figures monthly, have been reporting average inflows of $937.4 million a week the past four weeks. The continuous flood of new money into the $519 billion municipal bond mutual fund industry is bolstering demand during a supply drought.
State and local governments are slated to sell just $3.02 billion in new debt next week, according to The Bond Buyer and Ipreo data.
The Bond Buyer 30-day visible supply, which measures municipal debt scheduled for sale over the next month, is only $4.8 billion. Visible supply has been lower only a handful of times the past five years, mostly during the year-end holiday slowdown. The last time visible supply was lower was August 2006, with the exception of the notoriously sparse months of December and January.
The lull in issuance is only part of the story.
John Dillon, municipal strategist at Morgan Stanley Smith Barney, wrote in a report last week that the amount of municipal borrowing is secondary to the mix of taxable and tax-exempt bonds.
The supply shortage is not just a seasonal lull due to Labor Day and the Jewish New Year falling in the same week.
The muni market has grappled with a supply drought for the better part of a year because of the migration of municipal borrowing into the taxable bond market, courtesy of the Build America Bonds program.
Until last year, municipalities typically conducted more than 90% of their borrowing by issuing tax-free bonds. The BAB program, which was enacted last year, has enabled municipalities to sell taxable debt. The result has been more taxable bond issuance — a lot more — and less tax-exempt issuance.
Based on data from Bloomberg LP, nearly a third of municipal borrowing this year has been in the taxable market. That compares with 16.2% at this point last year, 6% in 2008, and 4% in 2007 and 2006.
The increase in taxable borrowing has been attended by a predictable decrease in tax-exempt borrowing.
New tax-exempt issuance year-to-date is down 14.6% from last year, 16.8% from 2008, and 27.4% from 2007.
Of the 585 municipal bond mutual funds in existence, all but one invest in tax-exempt debt under the terms of their charters. The inflows into the funds ensure a steady river of money chasing an ever-shrinking supply of tax-exempt debt.
According to the Investment Company Institute, municipal funds reported $69 billion in new money from investors last year — a sum equal to 21% of newly issued tax-exempt bonds in 2009. They have been entrusted with roughly $26.9 billion in new money this year, or 15.4% of new tax-exempt issuance. That compares with about 1.8% of tax-exempt issuance from 2000 to 2008.
It gets worse.
The BAB program is scheduled to expire at the end of 2010. Congress is considering an extension of some form, but is likely to do so with a lower federal subsidy for municipalities.
Dillon expects a crush of muni borrowing through BABs before the program expires at the current subsidy level, which is likely to produce a corresponding drop in tax-exempt borrowing.
“We expect a healthy and potentially escalating volume of BABs through the end of 2010, which should continue to be supportive of tax-exempt pricing,” Dillon said.
The 10-year triple-A rated municipal bond yield has shaved more than 40 basis points this year, according to the Municipal Market Advisors scale.
