Taxable issuance breathes life into primary market

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For the third time in the past four years, long-term municipal bond volume has surpassed the $400 billon mark — this time thanks to a second half surge in taxable issuance that took the market by storm.

Long-term municipal bond issuance finished 2019 with a robust total of $423.36 billion, a 22.3% increase from the $346.10 million from 2018. Those figures are according to Refinitiv.

“Aside from supply in 2018, which was distorted by the tax reform, $400 billion will likely become the new normal, as there is a lot of pent-up demand, and rates will likely remain relatively low for the foreseeable future,” said Mikhail Foux, managing director, head municipal research & strategy at Barclays.

Issuance was looking bleak for the entire first half, as the first five months of the year issuers sold less than $30 billion each month. The market was on pace for only about $346 billion at the halfway point of the year.

“The first half of the year looked ordinary and the last quarter and a half took on an entirely different tone,” Eric Kazatsky, municipal strategist at Bloomberg Intelligence, said. “In late summer, we were still thinking that full-year supply would be in the $350 billion camp. Not one person on the street saw this coming in terms of taxable supply and had a forecast to substantiate that.”

Then seemingly out of nowhere, the taxable issuance starting flowing and it didn’t stop. Third quarter issuance totaled $106.62 billion and fourth quarter volume came out to $143.64 billion.

“Fourth quarter was one of the heaviest periods of muni issuance in recent history; we saw a resurgence of taxable issuance (especially taxable advance refundings) after rates dropped last August,” Foux said. “Although tax-exempt issuance was also robust. Meanwhile, the first half of the year was surprisingly light — one of the main reasons for strong tax-exempt performance in the second quarter of 2019.

Taxable issuance increased 117.3% to $71.32 billion from $32.82 billion.

“Once it got going it was pretty amazing to see how many deals were coming and who was tapping the market for the first time,” Kazatsky said. “It left me with the feeling that the muni market is being reshaped and redefined ... especially if rates stay lower for longer.”

When rates are as low as they were in 2019, issuing taxable debt instead of tax-exempt debt has many positives for issuers.

“Borrowers are able to refund exempts and free themselves of the shackles that go along with the tax-exemption such as limitations on use of proceeds,” Kazatsky said. “Further, when they access the taxable markets they are tapping a deeper and new investor base that in some cases are willing to pay up to new names in the taxable muni space. Foreign and domestic buyers love the low beta to corporate credit risk.”

Foux added that taxable advance refundings used to be extremely uncommon before tax reform, and most issuers were simply not accustomed to placing taxable deals. However, after a 30-plus basis point drop in Treasury yields taxable advance refundings became very attractive to issuers.

“As more and more municipalities have started placing taxable deals, it became easier for other issuers to also join the party,” Foux said.

New money volume rose 9.5% to $264.07 billion, while refunding volume vaulted 77.3% to $107.24 billion from $60.49 billion.

“Both new-money and refundings surprised to the upside, everybody is talking about taxable advance refundings, but a surge in new-money issuance is also a big enough story,” Foux said. “Last year new-money supply was at the largest level in nearly a decade. In the past two years new money was the main driving force behind muni issuance, reminiscent of the new money/refundings split prior to the great recession, when rates were much higher.”

A good amount of the taxable issuance was refunding increased by six times to the tune $36.81 billion from $6.60 billion.

"Taxable advance refundings are not as efficient as tax-exempt refundings (although embedded calls help making them more efficient), but they still provide much-needed savings to issuers,” Foux said. “Additionally, the taxable market could be very deep, especially for larger ($300 million and above) deals, making it easier to place them.”

He noted that prior to last year, domestic and foreign investors were starving for taxable munis after they developed their appetite for the product during the Build America Bond years. Unlike corporates, most taxable munis rated double-A or higher, making these bonds very attractive to investors in the current global rate environment.

Taxable advance refundings are rate sensitive but even when they are not, issuers may opt to exit existing covenants.

“The 10-year U.S. Treasury bottomed out at about 1.45% in September and the rocket took off from there,” Kazatsky said. “There were most likely lots of deals in the pipeline which were dependent upon rates rallying to some degree. Keep in mind 2019 started with a U.S. 10-year of 2.74%.”

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