US investors hunt for yield in junk-rated municipal debt
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Investors are pouring into the $4tn US municipal bond market, pushing yields on debt issued by state and local governments across the country to the lowest level on record.
The voracious investor appetite has helped state agencies and governments lock in low borrowing costs and at times raise more money than bankers working on the projects initially anticipated.
The yield on the closely followed ICE BofA municipal bond index dropped to 0.95 per cent this week, the lowest reading since it was launched in 1991.
Some $49bn has been pumped into municipal bond funds this year, according to fund flows tracked by Refinitiv’s Lipper, with an outsize proportion directed to lower-quality debt. Despite accounting for just 5 per cent of the market by some estimates, junk-rated muni bonds raked in around a quarter of the inflows, a little over $12bn.
“It is such an incredible market for the issuers,” said Eve Lando, a portfolio manager at Thornburg Investment Management. “Interest rates are so low and the demand is so high.”
The rally in muni debt, and junk muni debt in particular, has been propelled by many of the same forces that have driven US stocks to record highs and kept yields in broad swaths of the fixed income market near recent lows. With interest rates tethered to zero in the US and a flood of cash injected into the financial system from successive stimulus programmes, portfolio managers have been ploughing into investments that could offer a higher return than Treasuries.
But the strength of the market is also a rebuke to those who feared the pandemic would lay waste to municipal finances across the US. As the economy rebounded more strongly than first feared, tax revenues took less of a hit and — despite strains, and in some cases real distress — municipal finances have held up.
Tax collections between July 2020 and April of this year were up on the prior year in 45 of the 47 states that provided information to the Urban Institute. More than 40 states reported stronger year-on-year corporate and personal tax revenues, with 38 showing higher general sales tax collections.
Congressional aid has filled gaps that some states and cities had feared would be difficult to close when they made budget projections at the nadir of the crisis. Peter Block, the chief municipal strategist at Ramirez & Co, said that some state finances were in the best shape he has seen in years, given that aid.
That has eased fears that state and local governments could face a bevy of downgrades from rating agencies in the months ahead. Analysts with Moody’s this week noted that while borrowing at the state level increased last year as governments responded to the public health crisis, federal aid helped reduce the median state’s debt-to-personal income ratio to a 20-year low.
Ted Hampton, a credit officer with Moody’s, said that the borrowing was driven “by a few large states, some of which is likely to be repaid quickly”.
Demand for municipal bonds has also been buoyed by the Biden administration’s intention to push for higher taxes to fund new healthcare, education and infrastructure programmes. A buyer of tax-exempt municipal bonds does not pay federal taxes on the income they receive from the debt, and they often are not taxed by their state either, so their appeal goes up when taxes do.
“Lots of tax shelters have been squeezed out over generations,” said Block. “Tax-exempt muni bonds are among the last tax shelters available that are easily accessible to the average person and somewhat liquid.”
John Miller, head of municipals at asset manager Nuveen, said that most recent deals have been significantly oversubscribed.
A slew of municipalities and state agencies have tapped investor demand already this year, and even rare borrowers are being tempted back to the market.
American Samoa, the junk-rated US territory that last tapped muni investors in 2018, has started marketing a bond sale that could raise tens of millions of dollars.
Many borrowers have been able to lock in more favourable terms than bankers indicated before they began roadshows marketing the new debt. Among these are Washington DC’s transit authority, which borrowed $784m in late May, and Chicago’s transit system, which raised $121m this month.
The enthusiasm extends across the spectrum of borrowers. A California agency that has plans to build a senior living community called Enso Village sold a 35-year bond at a lower than expected yield of 4.43 per cent. The debt was “many times oversubscribed”, Lando said.
Charter schools have also been particularly active in issuing debt this year. The schools are often seen by investors as riskier than lending to a public school system, given they are not backed by the taxing powers of a local government. This month Build NYC Resource Corporation borrowed $18m to fund a new seven-storey school for 600 students in the Bronx.
“When the market gets really revved up, you tend to see some deals that you kind of scratch your head and say this might not get done in normal times,” said Scott Diamond, co-head of municipal fixed income at Goldman Sachs Asset Management.
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