The parched market for municipal bond refundings may get some relief next year as call provisions kick in on debt issued a decade ago.
Refundings are likely to increase because bonds issued in 2004 with 10-year calls will be available to be refunded, analysts said. The increase in volume may ease the supply squeeze that has caused spreads to tighten this year, and allow investors to purchase lower-priced bonds in 2015.
"Based on issuance patterns there are fewer refunding candidates in 2014, and it should pick up in 2015," John Dillon, managing director at Morgan Stanley, said in an interview. "Based on historical issuance patterns, if you go back 10 years to 2004 and look at the issuance which had 10-year call protections, they're available to be called and some of them can be refunded."
Refunding issuances have remained low this year, totaling $21.71 billion through April 30, compared with $42.54 billion during the same period in 2013, according to Thomson Reuters' data.
This is only 24% of total issuance as of April 30, compared with the 34.7% refundings accounted for during the same period in 2013. Ronald Schwartz, CFA and managing director at StableRiver Capital Management, said in an interview the drop in refundings this year is one of the main reasons municipal supply has been scarce.
"What we've seen in the past is that refunding has been a major part of the total issuance, so this year [issuance] is down dramatically," he said.
The lack of refundings and consequential low total muni supply has shifted supply-demand dynamics in favor of issuers, causing bonds to be priced richly with tight credit spreads when they come to market. Issuance as of April 30 has totaled $89.34 billion this year compared to $122.72 billion during the same period in 2013.
The credit spread between 10-year triple-A GOs and GOs rated BAA have tightened by nine basis points from May 17,2013 to May 19 this year to negative 123, according to Municipal Market data.
Bank of America Merrill Lynch described credit spreads as "collapsing" in a report published on Monday.
Schwartz expects an increase in the amount of bonds available to be refunded will prevent sparse volume from repeating next year. Total volume for 2004 reached $358.3 billion, $24.8 billion more than 2013's total volume according to data The Bond Buyer collected as of February 2014.
Schwartz estimates that when refundings pick up issuance in 2015 total issuance will reach $300 billion.
"Next year there will be a new portion of bonds that will be qualified for refunding, so they will be more able to have some refunding in there," Schwartz said. "So along with more candidates for refunding we do feel like new issuance will increase in 2015."
Jim Colby, chief municipal strategist at Van Eck Global, said in an interview that rates were significantly higher in 2004 to 2006, and that issuers might want to take advantage of the current low rate environment.
On June 30, 2004 the Federal Reserve's fund rate was 1.25%, and had risen to 2.25% by December 15, according to data provided by federalreserve.com. The rate increased through 2005 and reached 5% on May 10, 2006. It was up again to 5.25% by June 29, 2006. The Fed funds rate is currently zero to 0.25%.
The yield on municipal bonds with two-year maturities has fallen to 0.34% as of May 14 from 2.11% on the same day in 2004, according to Municipal Market Advisors. The 10-year yield has fallen to 2.19% from 4.25% and the 30-year to 3.43 from 5.19%.
Yields for bonds priced at par were 0.46% for the two-year, 2.5% for the 10-year and 4.53% for the 30-year.
"[The] suggestion that there is plenty of room for refunding of 10-year debt is absolutely correct," Colby said. "Those rates are significantly higher than new issues coming to the market right now, which is exactly the point of refunding activity. It would appear that the elements are there in place for that sort of thing to happen."
Colby does say that some technical factors weigh against a pick up in refundings in 2015, such as the fact rates have been low for awhile and there might not be a significant amount of deals available that have not already been refunded. He also mentioned that if an issuer wants to refund a deal, it often finds ways to refinance in advance of a bond's official call-date.
"I know issuers don't wait until the 10-year call arrives at their doorstep to begin to potentially find ways to begin refinancing," he said.
Analysts said, however, that bonds issued between 2004 and 2006 probably would not have been refunded in advance because low rates have limited opportunities to put money from refundings to work elsewhere.
"2004, 2005 were big supply years with 10-year calls," Adam Buchanan, sales and trading vice president at B.C Ziegler & Co., said in an interview. "A lot of those bonds might have been advanced refunded in 2007 in the low interest rate environment, but as everyone knows advanced refundings have been difficult over the last years with the negative arbitrage."
Dillon said that before May of last year there had been some advanced refundings done using taxable municipals, but he said that has not been the case lately.
