Zeroes Cheapest on Record Seen in Reversal of Trend: Muni Credit
Municipal zero-coupon securities that push principal and interest payments out to the 2040s are the cheapest in 11 years compared with conventional tax-exempt debt. That may not last.
Zero-coupon bonds are sold at a discount to face value and pay interest and principal when they mature. Securities maturing in 30 years offered 1.53 percentage points of additional yield last month relative to similarly dated benchmark debt. While that’s the biggest spread since at least August 2001, according to data compiled by Bloomberg, the gap may narrow if interest rates rise, said Mikhail Foux at Citigroup Inc.
“Their yields are very cheap already, so if rates increase, their yields may not necessarily increase as much as coupon bonds,” said Foux, a strategist at the bank in New York.
Federal Reserve Chairman Ben S. Bernanke has said he would keep the central bank’s key lending rate near zero at least through 2014. The policy has helped states and localities sell $230.3 billion of long-term fixed-rate debt this year, $90 billion more than 2011, Bloomberg data show. Zero-coupon sales totaled only $1.2 billion as of Aug. 21, highlighting their relative scarcity. In 2011, states and localities sold $2.5 billion of the securities, the least since 2001.
Investors in the $3.7 trillion municipal bond market are buying lower-rated tax-exempt debt and longer-dated maturities to receive additional interest with rates at 45-year lows. High- yield U.S. municipal mutual funds added about $1.2 billion in the five weeks through Aug. 15, the most since December 2010, Lipper US Fund Flows data show.
Zero-coupon bonds appeal to issuers such as Puerto Rico, with credit ratings lower than those of any U.S. state, and school districts in California that need to build facilities even as property tax revenue has declined. Institutional buyers like the securities for their additional yield, said Jamie Pagliocco, director of bond managers overseeing $30 billion of municipals at Fidelity Investments in Merrimack, New Hampshire.
“People can be drawn to zero-coupons because of the additional yield that they provide, even though you’re not receiving those interest payments every six months like you would with a coupon bond,” Pagliocco said. “That’s pretty pervasive for our marketplace because of the low interest-rate environment that we’re in right now.”
Demand for U.S. Treasuries from investors looking for a haven from the European debt crisis has pushed down yields on federal and tax-exempt debt. Yields on municipals due in 20 years were 3.61 percent July 26, near the 45-year low of 3.6 percent on Jan. 19, according to a Bond Buyer index.
Interest rates on conventional municipal bonds have fallen faster this year than zero-coupon debt, widening the spread between the securities, Foux said. Yields on benchmark issues due in 30 years fell 0.48 percentage point since the start of 2012, more than the 0.02 percentage-point drop on zero-coupon yields with similar maturity, Bloomberg data show.
A recent zero-coupon bond deal sold in New York priced with higher absolute yields compared with a similar New York coupon deal. It also was cheaper relative to benchmark municipals.
New York’s Triborough Bridge and Tunnel Authority on Aug. 3 sold zero-coupon bonds rated AA-, Standard & Poor’s fourth- highest grade, with debt maturing in 2032 priced to yield 3.7 percent. That was 1.21 percentage point above benchmark munis with similar maturity, Bloomberg data show.
New York City Transitional Finance Authority on Aug. 9 sold conventional coupon bonds rated AAA with debt due in 20 years yielding 2.94 percent, 0.76 percentage point less than the Triborough Bridge and Tunnel zero-coupon bonds and 0.41 percentage point more than the benchmark index with similar maturity.
Investors are also swapping coupon bonds for zeroes.
Foux recommends selling Puerto Rico general-obligation coupon bonds, rated Baa1, Moody’s Investors Service’s eighth- highest grade, and buying the commonwealth’s zero-coupon debt backed by sales taxes. Moody’s rates the senior sales-tax bonds Aa3, four grades higher than the island’s general-obligation securities.
A Puerto Rico general-obligation coupon bond maturing in July 2041 traded yesterday with an average yield of 4.94 percent. That’s 0.54 percentage point less than a Puerto Rico Sales Tax Financing Corp. issue with a similar maturity that traded Aug. 15, the most recent transaction, with an average yield of 5.48 percent, Bloomberg data show.
Along with the additional yield, investors trade up in credit quality, he said.
“In terms of nominal yield, it’s a substantial increase and you’re moving into a better-quality credit,” Foux said.
Following are pending sales:
NEW YORK CITY INDUSTRIAL DEVELOPMENT AGENCY and WISCONSIN’S PUBLIC FINANCE AUTHORITY plan to borrow $315 million of airport- facilities revenue debt on behalf of Transportation Infrastructure Properties LLC as soon as today, according to data compiled by Bloomberg. The New York portion will refinance debt sold in 2001 that helped finance two air-cargo facilities at John F. Kennedy International Airport. Wisconsin’s part will refund debt sold to build and repair air-cargo facilities throughout the U.S., according to bond documents. Another $111 million of debt will be sold through private placement. Standard & Poor’s rates the bonds BBB-, its lowest investment grade. (Updated Aug. 22)
LOS ANGELES COUNTY METROPOLITAN TRANSPORTATION AUTHORITY is set to issue $448 million of sales-tax revenue bonds as soon as today, data compiled by Bloomberg show. Proceeds will refund debt sold in 2003, according to bond documents. Moody’s Investors Service rates the sale Aa2, its third-highest grade. (Updated Aug. 22)
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