What falling yields mean for municipals

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As municipal bond yields hover near record low levels, investors are looking to tax-frees for safety, reassurance and quality amid extreme volatility in the stock market.

Last week, yields on Refinitiv Municipal Market Data’s AAA benchmark scale for the 10- and 30-year bonds fell to their lowest levels since the curve was first set back in the early 1980s (1.29% and 1.93% respectively).

“We revise our total returns and MMD rates forecasts given our Treasury strategists' new expectations,” Morgan Stanley said in a Monday research note. “We now forecast the 10-year MMD to end the year at 1.25%.”

Bloomberg’s BVAL AAA callable yield curve also dropped to record low levels of 1.226% and 1.899% for the 10- and 30-year, respectively.

While yields moved up slightly on Monday, the overall trend has been downward since the start of the year.

The market may be seeing low yields for a while, Kimberly Olsan, senior vice president at FTN Financial, said in a Monday market report.

“Due to a host of reasons, municipals of all shapes and sizes have posted impressive gains this month. A surge in the calendar to over $10 billion (which covered more than $3 billion in taxable deals) initially brought the question of ‘Can the market absorb that much without any yield dislocation?’ The answer became clear when multiple deals saw price bumps AND secondary yields continued to press lower with follow-through activity,” said Olsan. “While these moves might have brought some trepidation a few months ago, the global rate picture and intra-market fundamentals point to what could be a sustained period at current levels.”

Patrick Luby, senior municipal strategist at CreditSights, noted the effect the drop in yields was having on indexes.

“The benchmark municipal yield curve has not inverted, but the rate on the SIFMA index (which tracks the yields on seven-day municipal variable-rate demand obligations) is higher than the 10-year fixed rate benchmark yield (1.35% for SIFMA [as of Aug. 14] versus 1.23% for the Bloomberg BVAL triple-A index on the same day, but which declined to 1.227% at the close on Friday),” Luby said.

He added that compared to Treasury yields, municipals are still rich in the one-, two- and five-year spots.

“Among the biggest movers last week, California GO yields tightened three basis points versus the triple-A benchmark and New York tightened 10 basis points,” he said.

Luby said he expected that mutual bond funds will continue to see inflows in the near future.

“The steady influx of new money into municipal bond mutual funds (now at 32 consecutive weeks, and counting) suggests that the rich valuations will not affect individual demand — at least not in the near term,” he said.
Alan Schankel, managing director at Janney, agreed, saying that low yields haven’t put off bond buyers from snapping up paper.

“The low-yield environment has not deterred investors, who continue to pour cash into muni funds,” he said in a Monday market report.

He added that this week's supply focus will be on the Lone Star State.

“The week’s primary calendar includes large GO (Aa3/AA/NR) and utility revenue (Aa2/AA/NR) issues from Houston, but much attention will be on Wednesday’s $8 billion note sale for Texas (MIG-1/SP-1+/F1+), given the recent volatility in short-term yields.”

Primary market
This week's muni bond and note calendar surges past $14 billion, with Texas issuers dominating the action.

On Tuesday, Citigroup will be pricing Houston, Texas’ (Aa3/AA/NR) $785 million of combined utility system first lien revenue refunding bonds. The deal consists of $540 million of Series 2019C taxable bonds, $160 million of Series 2019B refunding bonds and $85 million of Series 2020A forward delivery bonds.

Loop Capital Markets, Morgan Stanley, Goldman Sachs, Raymond James and UBS are co-managers. Masterson Advisors and TKG & Associates are the municipal advisors. Orrick is the bond counsel.

On Wednesday, Ramirez & Co. will price Houston’s (Aa3/AA/NR) $483.5 million of public improvement refunding bonds. The deal consists of $275 million of Series 2019A bonds, $185 million of Series 201BC taxables, $160 million of Series 2019B refunding bonds and $23.5 million of Series 2019C forward delivery bonds.

Barclays, Wells Fargo Securities, Frost Bank, Hutchinson, Shockey Erley and Jefferies are co-managers. Masterson Advisors and the RSI Group are the municipal advisors. Bracewell and Baker Williams Matthiesen are bond counsel.

Proceeds will refund certain of the city’s outstanding public improvement bonds and general obligation commercial paper notes. The bonds are direct obligations of the city and are secured by an annual ad valorem tax, levied within legal limits, on all taxable property within the city

Also Wednesday, Texas (MIG1/SP1+/F1+/K1+) will competitively sell $8 billion of Series 2019 tax and revenue anticipation notes. George K. Baum is the financial advisor; Orrick Herrington is the bond counsel.

This is Texas’ annual note sale and the biggest since 2012; the state sells notes each year to cover cash-flow gaps, especially for school districts. It had enough revenues on hand that it didn’t need to come to market in 2015 or 2016.

And Goldman Sachs is set to price San Antonio, Texas’ (Aa1/AA/AA+) $115 million of New Series of 2019 electric and gas systems revenue refunding bonds on Wednesday. Raymond James and Siebert Cisneros Shank ate co-managers. PFM and Estrada Hinojosa are the financial advisors. Norton Rose Fulbright and Kassahn and Ortiz are the bond counsel.

BlackRock looks at supply/demand dynamics
Peter Hayes, head of BlackRock’s Municipal Bonds Group, anticipates that the favorable supply-and-demand dynamic in the municipal market is likely to persist and that tax changes on advance refunding bonds have made it more difficult for the market to find balance.

"July was the ninth consecutive month of the muni market’s strong performance streak, with the S&P Municipal Bond Index up 0.77%, bringing the year-to- date return to 5.75%," he said. "Net negative issuance was met with robust demand amid a mostly benign interest rate environment."
The group, which oversees $135 billion of municipal assets anticipates that the favorable supply-and-demand dynamic in the municipal market is likely to persist.

Periods of falling interest rates have historically led to increased supply due to municipalities issuing new debt at lower rates to pay off their existing, more expensive debt," Hayes said. "However, the interest on such advance refunding bonds is no longer tax-free under the new tax law. This change has made it more difficult for the market to find balance when muted supply and robust demand are creating a strong market dynamic as we are seeing today and expect to continue."

Last month, the group moved from a shorter to a more neutral duration stance after interest rates moved higher. And it also tactically used hedges to adjust the overall duration and capitalize on interest rate volatility.

"We maintain a barbell yield curve strategy with concentrated exposures in maturities of 0-6 and 20+ years," Hayes said. "The fund’s overweight in 20+ years contributed to performance in July, while underweight in the range of 10-15 years detracted. We recently reduced exposure to terms of 25+ in favor of 0-3 years given the low levels of interest rates and historically rich valuations of municipals versus Treasuries."

He continued to say that they increased exposure to credits rated A while decreasing exposure to BBB. As of the end of July, approximately 18% of the fund’s net assets were high-yield municipal bonds.

"Given the dearth of supply, strong inflows and tight valuations in the market, we focused on identifying opportunities to tactically trade some high-profile issues in the primary market."

Secondary market
Munis were weaker in late trade on the MBIS benchmark and AAA scales, with yields rising about two to three basis points.

Yields moved higher on Refinitiv Municipal Market Data’s AAA benchmark scale, with the 10-year muni GO rising one basis point to 1.23% while the 30-year increased three basis points to 1.90%.

"Munis yields are ticking higher today, generally by one to two basis points across the curve on light volume," ICE Data Services said in a market comment Monday. "High-yield is holding its own; taxables are tracking the Treasury move upward."

The 10-year muni-to-Treasury ratio was calculated at 76.9% while the 30-year muni-to-Treasury ratio stood at 90.9%, according to MMD.

Treasuries were weaker as stocks traded higher. The Treasury three-month was yielding 1.902%, the two-year was yielding 1.537%, the five-year was yielding 1.461%, the 10-year was yielding 1.595% and the 30-year was yielding 2.081%.
Previous session's activity
The MSRB reported 26,627 trades Friday on volume of $7.74 billion. The 30-day average trade summary showed on a par amount basis of $11.28 million that customers bought $5.74 million, customers sold $3.43 million and interdealer trades totaled $2.12 million.

California, Texas and New York were most traded, with the Golden State taking 17.849% of the market, the Lone Star State taking 16.194% and the Empire State taking 10.092%.

The most actively traded security was the San Francisco Airports Commission Series 2019E revenue 5s of 2050, which traded 11 times on volume of $46.75 million. The SF Air 5s, originally priced at 122.354 to yield 2.39%, traded on Friday at a high price of 122.74, a low yield of 2.35%, according the MSRB’s EMMA website.

Last week's actively traded issues
Revenue bonds made up 51.35% of total new issuance in the week ended Aug. 16, down from 51.65% in the prior week, according to IHS Markit. General obligation bonds were 43.10%, down from 43.40%, while taxable bonds accounted for 5.55%, up from 4.95%.

Some of the most actively traded munis by type in the week were from New York, Puerto Rico and Illinois issuers.

In the GO sector, the New York City 5s of 2038 traded 39 times. In the revenue bond sector, the Puerto Rico Sales Tax Financing Corp. 4.329s of 2040 traded 58 times. In the taxable bond sector, the Illinois 5.1s of 2033 traded 31 times.
Week's actively quoted issues
Puerto Rico, Colorado and California names were among the most actively quoted bonds in the week ended Aug. 16, according to IHS Markit.

On the bid side, the Puerto Rico Sales Tax Financing Corp. revenue 5s of 2058 were quoted by 37 unique dealers. On the ask side, the Colorado Health facilities Authority revenue 3.25s of 2049 were quoted by 49 dealers. Among two-sided quotes, the California taxable 7.55s of 2039 were quoted by 21 dealers.

Treasury auctions discount rate bills
Tender rates for the Treasury Department's latest 91-day and 182-day discount bills were lower, as the $45 billion of three-months incurred a 1.900% high rate, down from 1.960% the prior week, and the $42 billion of six-months incurred a 1.840% high rate, off from 1.890% the week before. Coupon equivalents were 1.941% and 1.888%, respectively. The price for the 91s was 99.519722 and that for the 182s was 99.069778.

The median bid on the 91s was 1.850%. The low bid was 1.800%. Tenders at the high rate were allotted 83.81%. The bid-to-cover ratio was 2.51.

The median bid for the 182s was 1.800%. The low bid was 1.770%. Tenders at the high rate were allotted 2.21%. The bid-to-cover ratio was 2.86.

Gary E. Siegel contributed to this report.

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 Ziad Saba at 212-803-6079 for more information.

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Primary bond market Secondary market State of Texas City of Houston, TX State of New York State of California State of Illinois City of New York, NY Puerto Rico Sales Tax Financing Corp (COFINA)