ST. LOUIS – The municipal bond market is adjusting and surviving the negative aspects of tax reform, panelists said Tuesday at the annual meeting of the Government Finance Officers Association.

April was a “pretty good” month for the municipal bond market following the 30% drop in first quarter issuance, said George Friedlander, managing partner at Court Street Group Research.

April issuance was down only about 4%, he said during a discussion on the impact of recent legislative and regulatory changes.

Court Street's George Friedlander sees emerging bondholder risk in state politics.
George Friedlander, managing partner at Court Street Group Research

“There hasn’t been the disruption in the market we were concerned about partly because total issuance is down and partly because we are getting some support from retail and some support from foreign investors,” Friedlander said.

The drop in issuance at the beginning of the year was expected by many muni market participants because of the year-end rush to complete deals before tax reform was enacted.

The Tax Cuts and Jobs Act prohibited advance refundings after Dec. 31 and also threatened the continuation of tax-exempt private activity bonds until the final bill was negotiated.

Since the start of 2018, some issuers have used shorter call dates for new issues of munis since they won't be able to advance refund them.

Wisconsin, for instance, issued bonds in February with a five-year call date.

Florida has stuck with a 10-year call date. “I am loath to pay a higher interest rate today,” Ben Watkins, director of Florida’s Division of Bond Finance, said during the panel discussion.

Watkins, a member of GFOA's Committtee on Governmental Debt Management, said there is “no consensus yet” on alternatives to advance refundings, but some issuers have been doing taxable refundings and current refundings.

“I think swaps are a four-letter word and I stay away from them,” Watkins added.

On the demand side, the significant cut in the corporate tax rate to 21% from 35% was widely expected to reduce the market for munis among banks.

“It’s happening,” Friedlander said. Although the drop in demand by banks hasn’t been quantified yet, he said, it’s a substantial part of the “massive decline in private purchases.”

Holdings by property and casualty insurers will trend downward and retail purchases will “probably not” make up the difference, he said.

“There is good news,” Friedlander said. “The individual investor is massively over-liquid.”

There is more than $12 trillion invested in CDs, money market accounts and short Treasuries compared to only about $1.6 trillion in municipals and $600 billion or so in corporate debt, Friedlander said.

“Over time, that over-liquidity will help,” he said.

Another source of demand will be foreign investors because of low interest rates in Europe and other developed nations.

“They are more interested in municipals now than they use to [be] because they see U.S. corporate buyers are less of a factor,” Friedlander said.

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