Taxable municipal bond sales surged to a five-month high in the past week, attracting yield-hungry investors as tax free spreads tighten.
Investors' appetite for taxable bonds was shown by the success two large taxable deals that hit the market. A $500 million sale of Texas Public Finance Authority windstorm insurance association bonds and a $265.82 million issue of University of North Carolina Chapel Hill general revenue refunding bonds were aggressively sought after by investors, market participants said.
The deals pushed taxable issuance to $1.030 billion for the week, the highest since the week of April 20 and more than four times time previous week's total, according to Thomson Reuters' data.
"There's demand [for taxable munis] on the buy side because there are not a lot of places to go to get yield and there's not a lot of supply of fixed income products anymore," Adam Buchanan, sales and trading vice president at Ziegler Institutional Sales, said in an interview.
On Thursday the 30-year municipal bond was trading at 3.10% according to Municipal Market Data's benchmark obligation triple-A general obligation scale. The 30-year Treasury was trading seven basis points higher at 3.17%, according to Treasury.gov. In contrast, the 30-year taxable municipal bond was trading at 3.89%, according to MMD's benchmark taxable triple-A GO scale.
A spokesman for the Texas Public Finance Authority said its deal was fully subscribed. Brian Smith, director of treasury and risk management services at UNC Chapel Hill said the university is closing the transaction on Oct. 9.
Taxable Munis Offer Yield And Diversification
It's not just traditional municipal bond investors who are buying these taxable munis. Corporate bond yields have fallen so low that taxable munis are now being swapped in as a replacement, analysts said.
Interest is "quite high because we can use tax bonds as a substitute for corporate bonds on many accounts right now that corporate spreads squeezed in so much," said Paul Mansour, managing director and head of municipal credit research at Conning, which "actively participated" in the UNC deal. "For accounts that don't need a lot of liquidity were can get [them] these taxable deals."
Mansour said these bonds also appeal to investors that habitually buy corporates because they offer more diversity.
"If you look at the taxable bond universe, there are not many triple-A rated issuers in the market," Fred Bacani, Head of Fixed Income & Trading at Veritable LP in Newtown Square, Pa, said in an interview, "There's J&J, Exxon and Microsoft, three triple-A rated issuers in the corporate bond market. Since there's not much taxable supply and only a handful of triple-A rated names to begin with, the UNC deal offered an opportunity for traditional corporate bond investors to diversify their portfolio with a gilt-edged rated municipal name."
Buyers Prefer High Rated
When investors do look at taxable munis, they tend to prefer higher-rated bonds, analysts said.
"Most of the demand is for high grades on the taxable side," Buchanan said. "There's not a whole lot of taxable issuance in low rated credits, its mostly high grade stuff."
Mansour said his group tends to look at deals rated A or better, but considers A rated credits the "sweet spot." In general, he said, the taxable muni market is similar to the tax-exempt one where people sticks with certain ratings, sectors and states they favor.
"We like general purpose, education, and high quality healthcare," he said.
Investors sticking to credits similar to tax-exempt munis or corporates they usually buy is why both the unrated TPFA deal and the triple-A rated UNC deal received such high demand this week, analysts said.
"The two largest taxable deals this week had totally different investors or investor demand types," Bacani said. "The $500 million Texas Public Finance deal for Texas Windstorm Insurance was a non-rated deal that received strong interest from high- yield investors, particularly given the lack of supply of high yield paper. The other deal was a natural triple-A rated UNC deal that was on the other side of the spectrum in terms of credit quality, yield spread over Treasuries, and investor demand type."
Mansour said that life insurance accounts typically purchase taxable bonds, "because taxable bonds tend to be longer and they're looking for longer assets. Liquidity is not a factor for these accounts."
Buchanan said the bonds are often bought by property insurance companies as well as cross over buyers.
The spokesman for the TPFA and Smith said the buyers of their respective deals were institutional.
Issuers Take Advantage of Low Rates
UNC's Smith said the university issued the refunding bonds now because in the current interest rate environment, "we had an opportunity to refund some bonds to save money, and given the relatively small pricing differential between taxable and tax-exempt, we decided to go with taxable bonds since it allows us more flexibility over time with the use of facilities financed under the original transaction."
Bacani said he certainly thinks the decrease in rates has spurred more refunding activity.
"There is certainly an opportunity to issue taxable municipals with the low rates, strong demand, and 100% municipal-to-Treasury ratios on the long-end of the yield curve," he said.
Mansour also theorized that taxable issuers may be issuing right now to take advantage of demand for the product.
Bacani pointed out that taxable rather than tax-exempt financing liberates issuers from the burden of tax compliance.
"The actual savings are not easily quantified, but from what I'm told by bankers, it certainly is a burden issuers are happy to break free from," he said.
