As stocks surged and Treasuries swooned, municipal bond traders gauged the direction of yields as they looked ahead to what may be a downturn in issuance this year.
RBC Capital Markets, in a report on the newly enacted tax law, said annual municipal bond issuance is likely to be down in 2018, and volume in the first quarter will be substantially below average.
RBC now estimates volume for the year at $285 billion, down from its earlier forecast of $375 billion that was made before the passage of tax reform legislation, Chris Mauro, RBC senior municipal desk credit analyst, wrote in the report last week.
Due to both the restrictions in the tax law and the outsized number of bonds that came to market in December 2017 in anticipation of the law’s enactment, RBC sees a first quarter drought that will cause some risks and opportunities.
“The well below average Q1 supply will create a significant supply/demand imbalance that will result in a very favorable technical profile for the municipal market,” Mauro wrote. “In our view, the provisions in the new law will likely bolster household demand for municipals but moderate bank and insurance company interest the asset class.”
While the muni market breathed a sigh of relief after private-activity bonds were saved in the final version of the tax legislation, the muni market might want to keep its fingers crossed that things stay that way, Mauro said.
“The Joint Tax Committee estimated that the elimination of PABs would have produced nearly $39 billion in revenue over 10 years. While the PABs authorization was retained in its entirety in the tax bill negotiations, we note that it was a visible and significant provision and, as such, remains vulnerable to limitation or elimination if deemed necessary to finance future federal initiatives,” he said. “While private activity bonds have been mentioned as a possible financing vehicle for the Trump administration’s suggested infrastructure initiative, we fear that the funding needs associated with such a program could cause Congress to revisit the PABs provision and view non-infrastructure PAB/501(c)(3) as a convenient revenue raiser.”
The tax law’s limitations on itemized deductions may increase the attractiveness of tax-exempt interest for individuals, particularly those in high-tax states, the report said.
“While we expect demand for municipals from individuals to be very strong, the reduction in the corporate tax rate from 35% to 21% will likely reduce the appetite of bank portfolios and insurance companies for tax-exempt interest,” Mauro wrote. “However, we do not foresee any large scale selling from these investors. Further, we believe that many of these investors like the risk profile of the municipal asset class and may elect to stay in the market by moving down the credit spectrum to medium or lower investment-grade credits in order to hit their return parameters.”
The report also cited RBC’s concerns about the long-term credit implications of the new tax law. The elimination of the advance refunding authority will limit the ability of state and local governments to lower their debt service costs, the firm said.
Additionally, RBC worries the $10,000 limitation on SALT deductions may make it unpalatable for state and local governments, particularly those in high-tax areas, to implement needed tax increases, potentially impairing the fiscal flexibility and eroding credit quality over time.
Finally, RBC voiced its concern about the effect this limitation, combined with the mortgage interest cap, could have on property values in high-cost, high-tax states and that this factor could potentially erode local government and school district tax bases over time.
“Despite what we think are very favorable municipal market technicals heading into 2018, we believe both issuers and investors should remain cognizant of the potential for additional legislative assaults on the municipal asset class as new federal funding needs develop, and of the risk of credit quality erosion in high tax states, particularly at the local government level,” Mauro wrote.
The MBIS municipal non-callable 5% GO benchmark scale was mixed in late trading.
The 10-year muni benchmark yield fell to 2.273% on Tuesday from the final read of 2.278% on Friday, according to Municipal Bond Information Services. The MBIS 30-year benchmark muni yield increased to 2.744% from 2.737%.
The MBIS benchmark index is updated hourly on the Bond Buyer Data Workstation.
Top-rated municipal bonds finished mixed on Tuesday after the January roll into the new year. The yield on the 10-year  benchmark muni general obligation was unchanged from 1.98% on Friday, while the 30-year  GO yield rose one basis point to 2.55% from 2.54% according to a read of MMD’s triple-A scale.
Muni yields have been volatile over the last year. On the first trading day of the last year, Jan. 3, 2017, the 10-year muni yield stood at 2.32% while the 30-year yield was at 3.05%.
U.S. Treasuries were weaker on Tuesday. The yield on the two-year Treasury rose to 1.92% from 1.89% on Friday, the 10-year Treasury yield gained to 2.46% from 2.41% and the yield on the 30-year Treasury increased to 2.81% from 2.74%.
In late trade, the Dow Jones Industrial Average was up 0.24%, the S&P 500 Index rose 0.65% while the Nasdaq Index gained 1.34%.
On Tuesday, the 10-year muni-to-Treasury ratio was calculated at 80.3% compared with 82.3% on Thursday, while the 30-year muni-to-Treasury ratio stood at 90.7% versus 92.6%, according to MMD.
Prior week's actively traded issues
Revenue bonds comprised 56.41% of new issuance in the week ended Dec. 29, up from 55.91% in the previous week, according to Markit. General obligation bonds made up 38.10% of total issuance, down from 38.53%, while taxable bonds accounted for 5.49%, down from 5.56% a week earlier.
Some of the most actively traded bonds by type in the week ended Dec. 29 were from Puerto Rico, Illinois and Connecticut issuers, according to Markit.
In the GO bond sector, the Puerto Rico Commonwealth 8s of 2035 were traded 42 times. In the revenue bond sector, the Railsplitter Tobacco Settlement Authority, Ill., 5s of 2027 were traded 42 times. And in the taxable bond sector, the Connecticut Student Loan Foundation zeroes of 2034 were traded 17 times.
MSRB: Previous session's activity
The Municipal Securities Rulemaking Board reported 18,737 trades on Friday on volume of $7.30 billion.
This week’s calendar totals about $757 million, which is made up of $713 million of negotiated deals and $44 million of competitive sales.
RBC Capital Markets is expected to price the New Jersey Economic Development Authority’s $381.195 million of state lease revenue bonds for state government buildings on Thursday.
The offering is comprised of $197.275 million bonds for the Health Department and Taxation Division office project; $19.225 million taxable bonds for the Health Department office project; and $164.695 million of bonds for the Juvenile Justice Commission Facilities project.
Proceeds of the sale will be used to fund construction of Health Department and Taxation Division office buildings in Trenton and to finance building juvenile justice commission facilities in Ewing and Winslow townships.
The deal is rated Baa1 by Moody’s Investors Service, BBB-plus by S&P Global Ratings and A-minus by Fitch Ratings.
RBC is also expected to price the Socorro Independent School District, Texas’ $173.54 million of Series 2018 unlimited tax school building bonds on Thursday.
The deal, which is backed by the Permanent School Fund guarantee program, is rated triple-A by Moody’s and Fitch.
Stifel is set to price the Anaheim Successor Agency to the Redevelopment Agency, Calif.’s $110 million of Series 2018A tax allocation refunding bonds on Thursday.
The deal is rated AA-minus by S&P.
The competitive arena remains particularly quiet this week.
Quincy, Mass., is selling two issues of notes and of bonds on Thursday. The separate deals consist of $42.39 million of general obligation bond anticipation notes and $10 million of GO district improvement bonds.
The BANs are rated SP-1-plus by S&P and the bonds are rated AA-plus by S&P.
Previous week's top underwriters
The top municipal bond underwriters of last week included RBC Capital Markets, Goldman Sachs, Westhoff Cone & Holmstedt, Piper Jaffray and D.A. Davidson, according to Thomson Reuters data.
In the week of Dec. 24 to Dec. 31, RBC underwrote $249.6 million, Goldman $245.3 million, Westhoff $33.3 million, Piper $31.1 million, and D.A. Davidson $21.2 million.
Bond Buyer 30-day visible supply at $4.18B
The Bond Buyer's 30-day visible supply calendar increased $317.9 million to $4.18 billion on Tuesday. The total is comprised of $1.56 billion of competitive sales and $2.62 billion of negotiated deals.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation. Click here for a brief tour of the Workstation, or contact Vanessa Kim at 212-803-8474 for more information.