Bargains Abound in Treasury-Backed Munis Roiled by Money Markets

  • As funds face redemptions, funds unload holdings of municipals
  • Yields on Treasury-backed munis jump over U.S. bonds

The more than $100 billion exodus from municipal money-market mutual funds is creating bargains in an often overlooked corner of the tax-exempt-debt market.

An index of municipal bonds that are pre-refunded -- or paid off with the proceeds of Treasuries that are held in escrow -- yield about 1 percent, or almost double what one-year federal government securities return. That’s the biggest premium since January, according to data compiled by Bloomberg. For three-year securities, the yields are equal to 119 percent of Treasuries.

A Florida Municipal Power Agency bond backed by what are known as state and local securities and callable in October 2019 traded at 0.95 percent Tuesday, or 112 percent of a comparable federal government bond. A Sacramento Municipal Utility District bond callable in August 2018 traded Thursday at 184 percent of Treasuries.

“You’re buying a super-safe tax-exempt bond at a very attractive percentage of Treasuries,” said Peter Block, managing director of credit strategy at Ramirez & Co Inc., a New York-based underwriter. “Pre-re bonds haven’t been this cheap on a percentage basis in many years.”

The prices of the municipals have tumbled because tax-exempt money market funds are hemorrhaging cash in advance of rules aimed at reducing the risk of runs on the pools. Such funds have lost over $100 billion of assets since the beginning of the year, according to Lipper U.S. Fund Flows data, as investors shifted into ones that buy only government debt. Those funds are exempt from Securities and Exchange Commission rules effective Oct. 14 that require floating net-asset values -- exposing investors to the risk of market declines -- and impose liquidity fees and redemption suspensions if necessary.

To meet redemptions, municipal money-market funds are selling short-term debt, such as variable-rate obligations, notes and pre-refunded munis, which mature in one to four years. Yields on municipal securities that reset every seven days have spiked to 0.84 percent from 0.02 percent at the beginning of March.

“The bid for those has cheapened significantly as a result of the fund outlfows," Block said. “That’s infected not only one-year paper but it’s also infected out to three years. The front end of the muni curve has flattened mostly as a result of that.” 

Since the beginning of April, the yield difference between municipal bonds with one and five-year has narrowed to 0.32 percent from 0.53 percent, according to data compiled by Bloomberg.

Pre-refunded bonds are created by advance refundings, which allow municipalities to refinance securities before their call dates. Municipalities sell bonds and use the proceeds to buy Treasuries or other federally backed debt. The income from the government securities is used to pay off the higher-cost munis, so the securities effectively has as little risk to investors as U.S. debt.

Insurance company selling is also boosting pre-re supply, said Tim McGregor, who oversees $30 billion of municipal bonds at Northern Trust in Chicago. Issuers are pre-refunding bonds so insurance companies need to replace them with longer-dated securities that match their liabilities.

“It might go from a 15-year bond with a four-year call to a four-year maturity bond in which case they may sell them and then re-extend," said McGregor. Northern Trust has increased the percentage of pre-res in its muni portfolio to 10 percent from five percent a year ago, he said.

“We’ve been adding pre-res and we’ll continue to do so as long as these rates exist,” said McGregor.

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