Lessons from One Week in the Muni Bond New Issue Market

A look at one week’s worth of new issuance of municipal bonds illustrates key themes at work in today’s market—and the range of potential investment opportunities on offer.

Read time: 5 minutes

New bond issue supply can be considered a decent gauge of the health of the municipal bond market in our view because it gives a sense of how much capital is available and how many issuers have access to the funding they need. Over the past couple of weeks, there have been more than $10 billion of new bonds issued each week, indicating above-average supply.  On the demand side, Lipper reported that more than $2 billion flowed into municipal bond mutual funds last week, so we believe there is a good amount of money available to buy the new bonds.

During the week of June 8, portfolio managers had many choices of new issues in both the high-quality investment grade side and the lower-quality portion of the market (see Figure 1).  Due to the strong demand, many deals ended up being heavily oversubscribed, with far more orders from investors than bonds available for purchase. We thought it would be instructive to review some of the issues offered during that week, as they represent a microcosm of the key investment themes at work, and the potential opportunities available, in the broader municipal bond market.

Figure 1. List of Recent Muni Bond Issues Shows Range of Potential Investment Opportunities
Selected issues that came to market during the week of June 8, 2020

¹S&P ratings except for Frederick Memorial Healthcare and Cumberland Academy (both Moody’s).
²Student housing bonds.
³A charter school issuing through New Hope Cultural Education Facilities in Texas.
Source: Bloomberg and Lord Abbett. Information as of June 12, 2020.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

The Upper Tiers of Investment Grade
High-quality issues in essential service sectors have had similar performance to general obligation (GO) bonds this year, meaning they have outperformed other revenue bonds.  This is not to say that they no longer have the potential to be attractive choices for municipal bond investors; it just means that their yields are lower because investors don’t need as much compensation for the risk. They are good for investors seeking bonds with historical default rates near 0% and that they believe may be strongly positioned to weather future ups and downs in the economy.

Dallas Water and Sewer is a good example. The longest bond maturity on its recent deal was 2049, with a yield of 2.06%. This may seem low, but the tax-equivalent yield for someone in the 35% tax bracket is 3.17%. That can be compared to a 30-year U.S. Treasury bond with a 1.46% yield to get a sense of why it still represents value.¹

Southern California Metropolitan Water District is another good example, in our view. In its June deal, the 2040 maturity had a yield of 1.53%. That’s lower than the longer maturity of its Dallas counterpart, but in California this bond is also exempt from state income taxes, so its tax-equivalent yield is compelling compared to Treasuries for a resident of that state.

Other types of revenue bonds can have similarly high credit quality for different reasons. For example the University of Michigan has a large endowment, strong financials, and very selective admissions. The longest maturity of its recent deal (2050) had a 1.83% rate. Again, that yield is higher than 30-year Treasuries, even before factoring in the tax exemption which can also include state income taxes for Michigan residents. A bond offering from Michigan’s arch rival, Ohio State University (OSU), is also on the high end of investment grade. OSU’s deal had its longest maturity at 2030, with a yield of 1.07%. Once again this seems low, but when you compare it to a 10-year Treasury at 0.70%, and factor in the tax-equivalent yield, it looks relatively attractive.

A Look at A-Rated Municipal Bonds
Moving down to the A credit range, the issues get more interesting and require more credit research, but their historical default rates are also close to 0%, so they may represent a lot of value. Take the recent deal from Seattle University, with the longest bonds maturing in 2050 at a 3.43% rate.  Put that into the tax-equivalent bond calculator at a 35% bracket, and that gets you a tax-equivalent yield of 5.28%. That would be pretty hard to match in other markets with similar credit risk. This offering had tremendous demand, but as institutional investors we have the opportunity to access bonds in this type of deal if we have interest.

E-470 is a toll way in the Denver area that is well established and has strong financials. Its longest maturity was 2040, with a yield of 1.72%. Clearly there is a big variance in yields in this credit quality range based on: an issuer’s familiarity to market participants; its sector; whether the income has an in-state exemption; and the size of the deal, among other factors.  

Some deals are a little different than others in their sector. The recent offering for Lee Moffitt Cancer Center is an example. There are a lot of hospitals that issue municipal bonds but cancer centers are less frequent so they take more credit analysis; this uniqueness can potentially present interesting opportunities. This portion of the deal was $260 million in size and had its longest maturity in 2050 with $100 million of bonds being priced with a 5% coupon and a yield of 2.68%. This is a 4.12% tax equivalent for someone in the 35% tax bracket which is attractive compared to some fixed income opportunities in other markets. Moffitt was also well oversubscribed.

Potential Opportunities in BBBs and Below
Moving down to the BBB credit range, there was a student housing deal for Longwood University in Virginia.  This has been a tough sector recently with defaults for a deal at Texas A&M and another for a deal in Oklahoma. Students need housing but these deals are typically supported by the revenue from a specific dorm so they need to be analyzed carefully. The deal was issued by an authority in Farmville, Virginia and the bonds are exempt from both federal and state taxes. It was a $121 million deal with the longest maturity in 2059 being priced at a 4.63% rate. On a tax equivalent basis for someone in the 35% tax bracket, this is equal to a taxable equivalent yield of 7.12%. Since these bonds take a lot of research work, there is a more limited set of buyers, but this deal was also heavily oversubscribed.

Finally there is the high yield municipal bond market, which is made up of a wide range of issuers. The recent $75 million issue for Cumberland Academy, a charter school in Texas, was classified as a 144A deal, which meant it was only available to those considered to be sophisticated investors (each buyer had to sign a letter to participate in the deal). The longest maturity was 2050 with a 4.80% yield, which leads to a tax-equivalent yield of 7.38%, using the same factors we referenced earlier here. Many high yield municipal bonds do not get ratings, so this one would be considered somewhat more liquid because it has the rating.  We think it is interesting that the yield is not much higher than the BBB- rated student housing deal.  This is because the market viewed the risk of a standalone student housing dorm to be similar to a charter school despite the rating difference.

Summing Up
Here is what we hope readers take away from our glimpse into just one week in the new issue market. First, the wide variety of credits examined here illustrates the diversity of the municipal bond market, along with the broad range of investment opportunities available. Second, at the security level, portfolio managers have to assess issuers with widely differentiated characteristics--and operational and credit considerations--as they decide what to put into a portfolio. Third, investors should note that yields may be low compared to historical levels, but on a tax-equivalent basis, or even when doing a straight comparison with Treasuries, there are many attractive relative value opportunities now compared to other fixed income alternatives. Also, our brief survey shows the range of yields available based upon credit risk, GO/revenue status, sector, and deal structure.

There’s one final point we’d like to emphasize. The diversity of today’s muni market means that a wide range of expertise is needed in order to provide investment teams with the potential to take advantage of all the investments available. We believe this is one of the big advantages that a professional manager can offer in addition to market access to purchase these deals.

¹Yield comparisons between municipal bonds and U.S. Treasury issues in this commentary are as of June 12, 2020, and are based on data from Thomson Reuters MMD.