Written by: Galen True
A key provision in the 2017 tax-law change was the prohibition on tax-exempt advance refunding transactions, which is a fancy way of describing municipal issuers refinancing outstanding debt that has not reached a current call status. As such, in 2018 and 2019 we saw a sharp decline in bonds issued for refinancing purposes. This year, with the massive decline in absolute levels of rates, there has been a surge in refunding activity to capitalize on record low yields. However, this issuance has come with a twist – the bonds that are being issued are fully taxable to investors.
According to SIFMA, total municipal refunding issuance is up around 70% year/year through August 4th. That increase in refinancing activity has been driven by a surge in taxable municipal issuance, which is up over 300% year/year, and looks likely to surpass the prior full year peak of 2010. Although municipalities must pay higher rates to issue taxable bonds than the more traditional tax-free structure, the decline in rates this year has allowed for cost savings by calling tax-exempt bond issues and refinancing those with taxable bonds.
The increase in taxable municipal supply has been met with strong demand, allowing taxable munis to be a top performing investment grade sector in 2020. While they have performed well, we believe there is still relative value in taxable municipal bonds versus other taxable bonds sectors such as corporates.
The increased issuance has brought increased awareness to the space as investors globally contend with low, or in some cases, negative yields. In addition, significantly lower hedging costs has increased foreign interest in USD fixed income assets.
Sources: SIFMA as of 8/4/20, ICE/BofA Indices as of 8/21/20