In the 3Q 2020 issue of our quarterly publication, we:
- Discuss how the muni market is continuing its healing process with municipalities showing increased issuance
- Offer a view on how investment-grade colleges and universities offer good value for investors
- Provide an outlook on higher education noting that the next few years will be a time of stress and rapid change
The municipal market continued its healing process in the third quarter with municipalities showing increased issuance while fund flows remained positive following record volatility at the end of the first quarter and beginning of the second. Municipal governments took advantage of low rates and investor appetite as issuance set record levels in September ($47 billion). Additionally, with the election looming in early November, issuers are combating the anticipated market uncertainty that could occur after November 3. As a result, yields drifted higher, especially on the longer end of the curve after setting new record lows in August.
Municipalities have issues well above $340 billion in new debt year to date with about one-third ($102 billion) in taxable—rather than tax-exempt—municipal issuance. The reason for the increase in taxable debt is the technical change noted in the 2017 tax law that limits how much debt municipalities can refinance using tax-exempt bonds (called advance refundings).
With all rates at extremely low levels, municipal issuers find it advantageous to refinance tax-exempt debt using taxable issuance as a way to benefit from less restrictive IRS laws regarding how the proceeds can be used. On the one hand, the continued increase in taxable issuance is constraining available supply for most municipal investors who favor the tax exemption. On the other hand, the rise in taxable issuance continues to attract overseas investors who buy U.S. Treasuries and corporates. Large sovereign wealth funds and European and Asian insurance companies with long-term liabilities are large purchasers. Inflows into mutual funds and ETFs turned positive in mid-April and, despite one week of outflows, have remained positive for the last seven straight weeks, decreasing outflows to just $6.2 billion through July 1 according to Lipper. The result can be seen in the sharp rise in yields in late March (March 24 was the peak) followed by a sharp decrease at the end of the quarter—a sign of the healing process.
As COVID-19 and its effect on state and local government finances continues, the general obligations and utility bonds (i.e., water and sewer, public power) of these regimes outperformed revenue sectors that have been most affected by the pandemic—namely transportation, health care, and higher education.
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