Spotlight: Corporate Tax-Exempt Bonds | Lord Abbett
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Fixed-Income Insights

Here, we highlight three key sectors within this lesser-known corner of the tax-exempt universe.

Read time: 2 minutes

This article is from the forthcoming edition of The Muni Quarterly.

With media attention for the municipal bond market typically focused on general obligation bonds, and to a lesser extent, essential service revenue bonds, investors may not be aware of another type of tax-advantaged revenue bond: tax-exempt corporate bonds. These bonds are typically secured by a guarantee from the issuing corporation and carry the rating of the issuer.

The size of the overall tax-exempt corporate market is relatively small, representing only 2.1% of all outstanding municipal securities. That likely reflects the limited circumstances under which they may be issued. Corporations may issue tax-exempt bonds if the proceeds are used for certain public purposes, including water furnishing facilities, sewage plants, solid waste disposal operations, hazardous waste facilities, enterprise empowerment zones, and disaster recovery areas. Typically they fall into the category of private activity bonds where they give subsidized tax-exempt borrowing rates to corporate issuers for projects that can help the local economy.

To help familiarize investors with this asset class, we will focus on three representative sectors that have a fair amount of activity in the tax-exempt corporate bond market: airlines, prepaid natural gas, and energy.

Airlines

U.S-based airlines Delta, United, American, Southwest, and JetBlue have all issued tax-exempt debt. The bonds are secured by a guaranty of the issuing airline and may also be secured by a leasehold interest in the airport terminal or maintenance facilities. For example, Delta recently issued bonds secured by a leasehold interest in the carrier’s terminal facilities at LaGuardia Airport in New York City. In the event that Delta defaults on its lease, bondholders would have the right to re-lease Delta’s Terminal C facility to other airlines. Similarly, American Airlines recently issued bonds secured by a leasehold mortgage of certain terminal facilities at New York’s John F. Kennedy International Airport.  These types of bonds have been issued for many decades, and they support increased volumes and expansions of service at airports.

Prepaid Natural Gas

These bonds have been issued by municipal authorities, which develop power agreements to purchase and supply gas at lower costs for customers, and they typically are supported by agreements with large banks, including Goldman Sachs, Citi, Morgan Stanley, and Bank of America. In a prepaid gas deal, the bank enhances contracts, which have been created to purchase natural gas and then deliver the natural gas to municipal utilities over a long-term contract. In terms of credit risk, prepaid gas deals are structured for the risk to fall on the bank if any part of the supply and deliver contracts fall through. We view the credit risk of prepaid gas bonds to be identical to unsecured taxable debt of the bank. In the unlikely event that the utilities are unable to receive and pay for natural gas, the bank will either remarket the gas to another municipal utility or terminate the deal. In the latter instance, the bank is required to make a termination payment to fully redeem the bonds.

Energy

Nustar Energy, a midstream oil company, issued tax-exempt bonds earlier this year. Nustar transports petroleum products via pipelines and stores oil, gasoline, and other refined products at facilities across the United States. Another energy company that issued bonds this year is Marathon Oil; as an oil exploration and production company, Marathon has greater exposure to oil price risk.  These bonds are issued through municipal-sponsored authorities, which provide lower-cost financing to the corporations to support the economy and create jobs in the area.

A Final Word

We believe corporate tax-exempt bonds are an opportunity to diversify credit risk in Lord Abbett’s tax- exempt mutual funds. Also, they frequently have stronger liquidity characteristics than other municipal bonds because the credits are known to investors in other markets, creating a larger universe of potential buyers for the bonds. Our tax-exempt research team draws on the expertise of its counterparts in the firm’s taxable fixed-income and equity research groups to form investment decisions.

 

IMPORTANT INFORMATION

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government, in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state, and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

General obligation (GO) bonds are municipal bonds backed by the “full faith and credit” of a government, and are issued by entities such as states, cities, counties, and school districts.

Revenue bonds are municipal bonds backed by revenues from a specific projects or facilities (such as toll roads, water/sewer systems, or airports).

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action, as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product, or service may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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