Muni Drought Looms Af­ter De­cem­ber’s Flood

The Bond Buyer - - Front Page - By Chris­tine Al­bano

Af­ter De­cem­ber’s record break­ing storm of is­suance, a pe­riod of calm may be on the hori­zon for mu­nic­i­pal bond in­vestors in 2018.

Sup­ply surged to $ 57.89 bil­lion this month – a record for De­cem­ber – as is­suers rushed to com­pen­sate for the pos­si­ble elim­i­na­tion of some types of tax ex­empt bonds as part of the over­haul be­ing ham­mered out in Wash­ing­ton.

Though the fi­nal tax bill tak­ing ef­fect af­ter Dec. 31 pre­served the use of pri­vate ac­tiv­ity bonds and gov­ern­men­tal use bonds for professional sports sta­di­ums, it elim­i­nated the use of ad­vance re­fund­ings. It also

left buy­side strate­gists scratch­ing their heads over whether is­suers had enough sup­ply left to meet de­mand in the com­ing months.

“If De­cem­ber 2017 is the all- time record for mu­nic­i­pal bond is­suance, will the 1st half of 2018 be the all- time low?” asked David Tawil, pres­i­dent of Maglan Cap­i­tal.

“A scarcity of sup­ply could re­sult in stronger de­mand and tighter spreads gen­er­ally,” said Jef­frey Lip­ton, head of mu­nic­i­pal re­search and strat­egy at Op­pen­heimer & Co. said. “A par­tic­u­lar short­age of cer­tain types of bonds could al­ter the per­for­mance dy­namic for out­stand­ing bonds within those sec­tors.

“Rates, curve po­si­tion­ing, the uni­verse of cur­rently re­fund­able bonds and an out­look for the econ­omy in gen­eral – and for mu­nic­i­pal credit specif­i­cally – will all in­flu­ence sup­ply pat­terns in 2018,” Lip­ton said.

Over­all, buy-side ex­perts said an evo­lu­tion of the mu­nic­i­pal mar­ket is on the hori­zon.

“Go­ing into 2018, tax- re­form, even a wa­tered-down ver­sion, would al­ter muni mar­ket dy­nam­ics,” Lip­ton said in an in­ter­view be­fore the bill was com­pleted. “We see a very con­struc­tive tech­ni­cal land­scape tak­ing shape for early next year,” he con­tin­ued.

“While a lower in­di­vid­ual tax rate struc­ture would not be ex­pected to im­pact muni de­mand and val­u­a­tions, a sig­nif­i­cantly re­duced cor­po­rate tax rate of 20% — or pos­si­bly 21% or 22% — may in­flu­ence in­sti­tu­tional de­mand and may pro­duce a mod­est repric­ing of the tax- ex­empt yield curve,” Lip­ton added.

The bill signed Dec. 22 by Pres­i­dent Trump will lower the cor­po­rate tax rate to 21% from 35%.

How­ever, tax re­form won’t de­ter mu­nic­i­pal in­vestors from be­ing ac­tive in 2018, ex­perts said.

“We be­lieve that de­mand for the as­set class will hold up and we see good over­all per­for­mance,” Lip­ton said.

John Mousseau, di­rec­tor of fixed in­come at Cum­ber­land Ad­vi­sors, said in­creas­ing yield ra­tios in­flu­enced in­vestors in 2017 and will con­tinue to do so in the months ahead — pro­vided muni- to- trea­sury ra­tios re­main at­trac­tive.

Ten- year mu­nic­i­pals are cur­rently yield­ing 84.4% of the yield of com­pa­ra­ble Trea­suries, while the 30- year mu­nic­i­pal bench­mark is yield­ing 94.4% of the 30- year Trea­sury as of Dec. 22, ac­cord­ing to MMD. The ra­tios in 10 and 30 years have been as high as 98.5% in 10 years and 103.5% on the 30- year in the last 12 months.

Rick Cal­houn of Crews & As­so­ci­ates said in­vestor’s re­cent strat­egy of buy­ing longer bonds could change in 2018 as the yield curve con­tin­ues to flat­ten, though tax pay­ers will still be in­flu­enced to heav­ily in­vest in tax- free se­cu­ri­ties.

“It ap­pears that in­vestors in higher in­come brack­ets may ac­tu­ally see their taxes go up and higher taxes may in­crease mu­nic­i­pal bond de­mand,” Cal­houn pre­dicted.

Is­suers will also be im­pacted in a big way in the com­ing year, ac­cord­ing to the ex­perts.

“An in­abil­ity for is­suers to rely on ad­vance re­fund­ings as an ef­fec­tive debt man­age­ment tool may di­min­ish fi­nanc­ing flex­i­bil­ity for those bor­row­ers who al­ready have lim­i­ta­tions,” Lip­ton said.

“The ques­tion for 2018 is whether any en­tity – city or state -- will achieve mean­ing­ful pen­sion re­form,” Tawil of Maglan said. The type of fed­eral hur­ri­cane relief pro­vided to Puerto Rico and the U. S. Vir­gin Is­lands will also set an im­por­tant prece­dent for forth­com- ing dis­tressed mu­nic­i­pal sit­u­a­tions — “if ex­ist­ing debt is primed by a fed­eral loan.”

Oth­ers turned their at­ten­tion to credit risk in the New Year.

“Given our po­si­tion that mu­nic­i­pal credit qual­ity has plateaued, we are very much con­cerned over any devel­op­ment that could ad­versely im­pact fu­ture credit qual­ity,” Lip­ton of Op­pen­heimer added. q

“If De­cem­ber 2017 is the record for mu­nic­i­pal bond is­suance, will the first half of 2018 be the all-time low?” asked David Tawil, of Maglan Cap­i­tal.

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