Trading at ’05 Low Signals Buy During Sales DroughtBrian Chappatta
Trading in the $3.7 trillion municipal market has fallen to the lowest level since 2005. For investors, that’s a sign to buy as states and cities throttle back new debt sales to the least in two decades.
Rather than borrow to start projects such as roads and bridges, cities and states are refinancing higher-cost obligations at the fastest clip since the 1990s after yields sank to generational lows, Bank of America Merrill Lynch data show.
While tax-exempt yields are the highest in 11 months, net borrowing will probably remain at half the historic level for the next decade, which is “bullish for prices,” said Matt Fabian, a managing director at Municipal Market Advisors, a Concord, Massachusetts-based research firm. With less new debt coming to market, investors such as Gary Pollack at Deutsche Bank AG’s private-wealth unit say they’re reluctant to part with bonds.
“Since the net supply of municipal bonds is falling, I’m a bit more hesitant to sell items that I may not be able to get back in the secondary market -- or even the primary market,” said Pollack, who oversees $6 billion of munis as head of fixed-income trading in New York for the Deutsche unit.
Munis join other fixed-income assets changing hands less frequently than before the 18-month recession that ended in 2009. In the past year, $247 billion of Treasuries traded among the 21 primary dealers in an average week, according to data from ICAP Plc, the largest interdealer broker of the debt. In the year before the collapse of Lehman Brothers Holdings Inc. in September 2008, volume was about 25 percent higher.
Muni transactions fell by about $60 billion to $3.2 trillion last year, the lowest since at least 2005, according to the Municipal Securities Rulemaking Board. The number of trades sank by 700,000 to 9.7 million, the least since 2007.
State and local bonds trade less frequently than their federal and corporate counterparts as individual investors own almost half the tax-exempt market directly, Federal Reserve data show. Those investors typically hold the securities to maturity. A third of muni trades occur within a month of issuance when measuring by dollar amount, MSRB data show.
New bond sales trailed the amount of money investors received from maturing and refinanced debt by about $5 billion in 2012, the second-straight year of so-called net negative issuance, Fed data show. It’s the longest such streak since 1995. From 2005 to 2007, average issuance exceeded that cash flow by $196 billion annually as municipalities ramped up borrowing for new projects before the financial crisis.
As localities repair their finances following the recession, they are reducing interest costs by refinancing at lower yields. When cities and counties buy back bonds and issue new securities at reduced rates, they leave muni supply unchanged. The New York City Transitional Finance Authority plans to sell $1 billion in bonds tomorrow, with about a quarter of the offer going toward refunding.
Refinancings composed 62 percent of local debt sales in 2012, the most since 1993, according to John Hallacy, head of muni research in New York at Bank of America Merrill Lynch.
“It’s going to be a thinner, more hotly contested market” with fewer bonds to trade, said Fabian at Concord, Massachusetts-based MMA.
Lower-rated munis are among areas benefitting from the shortage. The yield penalty on BBB munis relative to top grades narrowed last week to 0.97 percentage point, the lowest since September 2008, data compiled by Bloomberg show.
High-yield buyers piled into the segment after localities sold just $552 million of noninvestment grade local bonds last year, the least since 2009, according to Moody’s Investors Service data compiled by Bank of America. Invesco Ltd. closed its $7.2 billion High Yield Municipal Fund to new investors in September because demand was outpacing investment opportunities.
“We’ve been dealing with low supply in our marketplace for a long time,” said Mark Paris, a senior portfolio manager at Invesco in New York. “When you look at calls, redemptions and inflows relative to supply, that’s what really has given the BBB space a boost.”
The scarcity serves as a cushion for muni yields as bonds lose appeal amid signs of a strengthening U.S. economy. Investors withdrew about $113 million from muni mutual funds last week, the biggest outflow this year, Lipper US Fund Flows data show.
At 2.04 percent, yields on benchmark 10-year munis are close to the highest since April, Bloomberg Valuation data show.
They have exceeded the interest rate on comparable-maturity Treasuries for four straight trading days, the longest span since December, Bloomberg data show. The ratio is about 105 percent, compared with an average of about 92 percent since 2001. The higher that percentage, the cheaper that local bonds are relative to their federal counterparts.
Munis typically lose value this month as investors dispose of the securities to pay tax bills before the April 15 filing deadline, Bloomberg data show.
Such selling “may still have a week or so to run,” Fabian at MMA said in a report yesterday.
States and cities are set to borrow $9.5 billion this week, the busiest period this year, Bloomberg data show. In the biggest sale, the New Jersey Turnpike Authority plans to offer $1.4 billion of tax-exempt securities tomorrow. Proceeds will help finance road-widening and bridge upgrades.
Following is a pending sale:
ILLINOIS plans to issue $800 million of general-obligation bonds via competitive sale April 2, after settling this month with the U.S. Securities and Exchange Commission over fraud charges. The regulator said Illinois misled bond investors from 2005 to 2009 about shortfalls in its retirement funds. The state postponed a $500 million offer in January after Standard & Poor’s downgraded it to A-, six steps below AAA. Illinois is the company’s lowest-rated U.S. state. (Added March 19)