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December 15, 2020

Weekly Municipal Monitor—Taxable Issuance Driving Record Supply

By Sam Weitzman

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Municipal Yields Moved Lower Across the Curve

Municipal yields moved lower across the curve, but underperformed Treasuries. Municipal technicals remained favorable as positive fund flows continued. A record issuance year was driven by heightened taxable supply. AAA municipal yields moved 2-4 bps lower across the curve. Ratios moved higher as municipals underperformed Treasuries during the week. The Bloomberg Barclays Municipal Index returned 0.16%, while the HY Muni Index returned 0.65%. This week we discuss how taxable muni issuance is driving record supply levels.

Municipal Technicals Remain Strong, Supported by Positive Fund Flows

Fund Flows: During the week ending December 9, municipal mutual funds recorded $992 million of inflows, according to Lipper. Long-term funds recorded $304 million of inflows, intermediate funds recorded $549 million of inflows and high-yield funds recorded $365 million of inflows. Municipal mutual fund net inflows YTD total $35.8 billion.

Supply: The muni market recorded $13.9 billion of new-issue volume, up 53% from the prior week. Issuance of $484 billion YTD is 15% above the 2019 calendar year, primarily driven by taxable issuance as tax-exempt issuance is tracking 2.3% lower year-over-year (YoY). This week’s new-issue calendar is expected to decline to $7.9 billion (-43% week-over-week). The largest deals include $1.5 billion taxable New York City GO and $800 million State of Connecticut transactions.

This Week in Munis: Taxable Issuance Driving Record Supply

Total municipal supply eclipsed $484 billion as of December 11, according to Bloomberg. This is 15% above full calendar year 2019 levels and 30% above the prior 10-year average. The banner year for municipal issuance was largely driven by increased taxable issuance which, at $177 billion, comprised 37% of total YTD issuance. This is more than double calendar year 2019 taxable issuance levels, and over 3.3x the prior 10-year average.

The windfall of taxable municipal supply was largely driven by the 2017 Tax Cuts and Jobs Act legislation, which prevented municipalities from advance refunding outstanding debt with tax-exempt securities. As Treasury rates reached record lows, it became more economical for municipal issuers to refinance outstanding tax-exempt debt with taxable securities.

Notably, while overall municipal issuance is higher YoY, tax-exempt issuance is tracking 2.3% lower YoY. Lower new money issuance, combined with redeemed debt associated with taxable refinancing, has supported a heightened scarcity value for the tax-exempt asset class.

Looking forward to 2021, we expect total municipal issuance to remain at or above 2020 levels as municipalities solve for latent infrastructure needs and fund long-term budgetary challenges. In our base case where long rates remain anchored, taxable issuance should remain elevated and continue to offer opportunities for a growing global investor base. Meanwhile, the relative scarcity of tax-exempt munis should support low borrowing costs via the traditional tax-exempt borrowing medium, at a time when munis need it most.

Exhibit 1: Annual Municipal Issuance
Explore Annual Municipal Issuance.
Source: Bloomberg, Bond Buyer. As of 11 Dec 20. Select the image to expand the view.
Exhibit 2: Municipal Bond Yields and Index Return
Explore Municipal Bond Yields and Index Return.
Sources: (A) Muni yields: Thomson Reuters MMD; Treasury Yields: Bloomberg. As of 11 Dec 20.
(B) Bloomberg. As of 11 Dec 20. Select the image to expand the view.
Exhibit 3: Tax-Exempt and Taxable Municipal Valuations
Explore
Sources: (A) Bloomberg, Western Asset. AAA, AA, A, BBB Corporate Indices. After-tax yield assumes a top effective tax rate of 40.8%. As of 11 Dec 20.
(B) Bloomberg, Western Asset; Taxable Muni Index Corporate comparable used is the long corporate (ex. BBB) to better align credit quality and duration. As of 11 Dec 20. Select the image to expand the view.
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