Skimpy Season for Reinvesting

Market participants say buyers will face slim pickings as they attempt to reinvest a flood of cash from called or maturing bonds during the summer reinvestment season.

According to Interactive Data, there is an estimated $78 billion in total redemptions coming due in the two-month summer rollover season — $48 billion on June 1 and $30 billion on July 1.

That would be another near record following last year’s season, when June 1 payouts totaled $60 billion, and July 1 saw $41 billion, according to the Bedford, Mass.-based financial information services company.

Total redemptions include principal payments on maturing bonds and notes as well as bonds being redeemed prior to maturity, the firm said. And those figures don’t include interest payments being made in June and July.

Analysts noted it will be a challenge for investors to find a home for all that cash with new-issue volume down sharply and poised to be the slimmest since 2000. About $80 billion in new volume has crept into the municipal market so far in 2011, compared to the more than $170 billion issued through the end of last May — a downward spiral of about 51%, according to Thomson Reuters.

Scarcity should help keep prices high and rates low, analysts said.

“Typically, June and July are the largest months for reinvestment, and this particular year, 2011 seems to be the largest on record,” said Chip Peebles, senior vice president and manager of retail trading at Morgan Keegan & Co.

“Coupling that with a calendar that is, at best, 50% of what it was last year, it should bode well to hold muni rates about where they are,” he said.

The 30-day visible supply was estimated at $6.57 billion as of Tuesday, down $255 million from the previous session, according to The Bond Buyer. Despite a brief sell-off on May 19 that interrupted a month-long rally, the desultory primary market continues to preclude higher yields, sources said.

On the heels of Friday’s volatility in the Treasury market, which rallied on Euro debt concerns and weak U.S. data, the post-holiday municipal market on Tuesday continued its quiet tone and saw two-year bonds yielding 0.44%, while the 30-year yield was at a 4.30%, according to Municipal Market Data. The 10-year bond, meanwhile, was at 2.65% — 62 basis points lower than on April 11, when the rally began, It has recently been down by as much as 68 points.

Volume usually drops ahead of major holidays, as it did with the arrival of the Memorial Day weekend, and volume this holiday-shortened week was expected to be about $2.5 billion. Weekly new volume for most of 2011 has been reduced to between one-fourth and one-half of the $8 billion average that was the norm in 2010.

As investors become more hard-pressed to find bonds, experts say many will be forced to hold onto cash until supply improves, or else consider other strategies.

The dearth of supply is making the reinvestment season more challenging than usual, according to Peebles.

“They are going to be holding out, but, forced by the cash build-up in their accounts being so large, they will be compelled to do something” despite the continued rally, he said.

“The outstanding question is whether now that state budgets are largely resolved, will issuers be able to hold off borrowing?” said Tom Doe, chief executive officer of Municipal Market Advisors in Boston.

“There is a great deal of pressure between maintaining fiscal prudence and borrowing for a project that will create jobs. In the first half of 2011, the former won out,” he said.

Some retail investors began investing their June 1 money before the proceeds have arrived, if and when a suitable deal was available.

“We have already seen investors investing their June money. … Firms harvest in May what is due in June,” Doe said.

“Some firms can buy bonds 30 days ahead of maturity, stated calls, and pre-refundeds, and they will do so to allow for reinvestment,” Peebles said.

In the past, this phenomenon has resulted in strong May performance followed by a weaker June, Doe said. “June has been weak in recent years because bankers brought deals counting on the demand that was applied earlier,” he said.

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, said in light of steadily rising prices, “the hunt for value is certainly on.”

“We are already seeing increased reinvestment from our retail base as May wears down, despite the absolute low level of returns,” he said.

Retail investors are active on different ends of the maturity spectrum as reinvestment season approaches.

“Very conservative buyers have almost become more so in recent weeks and are actually shortening up maturity preferences in anticipation of higher yields,” LeBas said.

“With the yield curve as steep as it is, it tells you that the front-end demand is insatiable,” Peebles said.

Others are extending out beyond 15 years to take advantage of attractive rates for longer bonds, given the steeper yield curve.

Yield-starved retail investors are willing to extend longer than usual on the maturity spectrum to avoid the paltry, sub-1% yields on the short end where some of their peers are camping out lately. They want to take advantage of the opportunities presented by the steep yield curve — if they can find bonds, Peebles said.

“They are definitely still buying [out long] because the alternatives are still pretty low and few and far between,” he said.

Peebles said a majority are avoiding the intermediate slope of the curve altogether.

“The belly of the curve between 10 and 15 years tends to be no-man’s land for retail because there is not enough yield,” he said, adding that that part of the curve is historically dominated by institutional buyers.

The low yields and the supply shortage has forced some investors to venture beyond their usual comfort zone to seek paper with different structures, maturities, and credit quality to fill the void in their municipal portfolios.

“More flexible buyers have been looking to alternative credits, but generally in the higher-quality spectrum,” LeBas said, noting that Janney retail clients are buying double-A hospital names, for instance, which the firm views as “cheap, relative to their credit risk.”

Others, meanwhile, said that even though it may take some time, they believe redemption proceeds will eventually be reinvested in the municipal market.

“With the Meredith Whitney meltdown in the rearview mirror and the stock market showing some signs of lethargy after a big run, there could be a large percentage of [the summer proceeds] reinvested,” said John Mousseau, a portfolio manager at Cumberland Advisors in Vineland, N.J.

“We have had a big run in the muni market, so we are thinking there will be more interest in premium bonds and bonds that have some defensive characteristics to them,” Mousseau said.


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