- Despite record supply, issuance has been uneven, with intermediate maturities growing and long maturities falling.
- Opportunities remain in certain sectors.
- Issuers are conforming to market desires and going short.
Issuance this year has been uneven across the curve, with intermediate maturities benefiting from growth in new-money borrowings while longer-term supply has fallen due to lower levels.
Overall, most issuance comes from new money, driven by the inability to delay much-needed infrastructure upgrades. And with higher rates, refundings don't make sense.
Tax-exempt supply this year shows a shift toward the six- to 10-year maturity bucket, up 30% year-over-year, with new money responsible for the rise rather than refunding activity.
A majority of the new-money issuance in the intermediate part of the curve comes from gas prepays, with a $13.7 billion rise in the six- to 10-year segment, according to J.P. Morgan.
Meanwhile, issuance in the 21- to 30-year sector has fallen 19% and the 30-year-plus segment has decreased 25%, the slower pace reflective of falling new-money borrowing, the firm said.
The long end is not seeing as much issuance from typical new-money issuers, like airports and other entities, because the absolute levels of yields are too high, and "so they're maybe a little hesitant to issue for new projects at that point or at that part of the curve," said Chad Farrington, co-head of municipal bond investment strategy at DWS.
"Heavier intermediate-maturity issuance has created pressure in the belly of the curve, while the scarcity of long-dated supply, combined with increased inflows into longer-dated products, has supported the long-end of the curve," AllianceBernstein strategists said.
As such, year-to-date performance across the curve has not been uniform.
Seven-year (6-8) maturity buckets are seeing gains of 0.19% year-to-date, while 10-year (8-12) and 15-year (12-17) maturity buckets are seeing losses of 0.26% and 0.44%, respectively.
Twenty-year (17-22) and long bonds (22 years and longer) maturity buckets have posted positive returns of 1.45% and 1.21%, respectively.
Opportunities
The underperformance in intermediate maturities has led to opportunities, especially in sectors like prepay gas and alternative minimum tax airport bonds, "where the inverted AMT spread curve adds additional potential for price appreciation in the belly," AllianceBernstein strategists said.
Many retail investors prefer to stay short- to intermediate-term, and given that most of the muni market is dominated by retail investors, it makes sense that much issuance is in the short- to intermediate-term, said Cooper Howard, director of fixed income research and strategy at Charles Schwab.
The growth of SMAs — which now total $1.6 trillion assets under management — is a driving force behind increased issuance in intermediate maturities, as SMAs prefer the short and intermediate parts of the curve. Given this demand, some issuers have started structuring deals to appeal to SMAs.
Lower costs
Issuers tend to have some flexibility overall in structuring and couponing, and tailoring issuance 10 years and in is an ongoing conversation between the sellside and buyside. While not always possible, it should theoretically translate into a better deal, meaning a lower interest cost, market participants said.
SMAs have seen growing interest in the prepay energy sector, which ranked as the second-largest sector by volume within the muni market at the end of July. Issuance in the first half of the year was $26.6 billion, almost double the pace of the same period last year, according to J.P. Morgan.
Deals in the prepay sector used to come in 20- and 30-year tranches to meet the needs of mutual funds, banks and insurance companies, the only buyers then.
Now that SMAs have stepped in, "you're starting to see those prepaid [deals] come more serial in nature, and out to 10 years to meet it," said Kyle Gerberding, director of trading, a portfolio manager and partner at Asset Preservation Advisors.
Furthermore, with the curve being so steep, issuers are willing to "load up" more on the short end of the curve where rates are lower, and they're locking in a lower rate there than having to go out to the 20-, 30-year part of the curve, he said.
There are still "big, old tranches" out in 20 to 30 years, but that is more expensive for issuers, Gerberding said.
Additionally, there tends to be more demand on the shorter and intermediate parts of the curve, an area where a lot of the lower valuations are, "so you can get a little bit cheaper borrowing at that point," Howard said.
It's not necessarily a big surprise that issuers will want, whether it's a new issue or refunding, to focus on the intermediate part of the curve "given where we're at with yields and given the steep curve," Farrington said.
"If you're an issuer, it's an extra 100 basis points to go from 10- to 30-year debt. If you can issue in short, why not?" he asked.
