The Muni Supply Spike: Bond Buyer Visible Supply
Cumberland Advisors | Dec 02, 2014 01:35AM ET
The Bond Buyer Visible Supply represents the amount of municipal bonds to be offered by dealers over the next 30 days. This week we have seen a spike of over $18 billion in supply. This spike is in a market that has been averaging about $8 billion in new issuance. It averaged much less earlier in the year.
A large amount of this issuance will be used to refund older higher-coupon bonds that were issued in 2005. Those bonds are now approaching their 10-Year call. New bonds with lower yields can now replace those older ones. This is a tried and true method for issuers to manage and lower their overall debt-service costs. Many of these 2005 issues were bonds issued to advance-refund even older higher-coupon bonds (issued at around 6%) in the late 1990s. During that time interest rates were much higher and were reflected in the stock market tech craze. IRS rules prohibited the issuers from advance-refunding these 2005 issues. Issuers can refund the bonds once the call date is reached, and that is what they are doing. We think this activity puts pressure on the municipal bond market. Even though the amount of net new issuance does not drastically change (example: selling $100 million new bonds and calling in $100 million older higher-coupon bonds), the issues still have to clear the market. There is clearly some money rolling over at year-end to absorb some of this, but the sheer size of the calendar should allow for some softening of prices.
This phenomenon should continue through much of 2015 and into 2016 – not all the time but most acutely at the junctures of large maturities of bonds – that is, January and July. We expect this to be a fairly good opportunity to buy longer-dated municipal bonds at municipal-to-Treasury yield ratios approaching 135–140%. This is excellent value in our opinion, given the ratios and the extreme difference in yields between shorter-term and longer-term bonds. We will keep readers informed.
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