Taxable Muni-Bond Sales Surge as Window Opens for Refinancings

(Bloomberg) -- A window of opportunity has led state and local governments to flood the muni-bond market with refinancings.

State and local governments issued $11 billion of refunding bonds in September, nearly matching the $12.9 billion sold in August when rates fell to record lows. More than a third of the sales during the past two months were taxable debt, showing that rates have fallen so much that states and cities can still capture lower borrowing costs even though President Donald Trump’s tax cut law bars sales of tax-exempt debt for a key type of refinancing.

It’s unusual for state and local governments to issue taxable bonds to replace tax-exempt debt, which cost them less, but “the numbers just work right now,” said Ben Barber, head of municipals at Goldman Sachs Asset Management. “What’s happened is that the rates have come down so much, that issuers are able to sell taxable munis at much lower rates than they were a year ago,” he said.

Taxable Muni-Bond Sales Surge as Window Opens for Refinancings

When municipal issuers refinance debt ahead of the bond’s scheduled call date, new bonds are brought to market and the proceeds are dumped into an escrow account usually filled with short-term Treasury bonds. Then when the call date approaches, that money is used to take out the older debt. In the last two months those short-term Treasury rates didn’t fall as much as yields on taxable longer-dated munis, creating an opportune environment for the sale of so-called advanced refundings.

Prior to the Tax Cuts and Jobs Act in 2017, state and local governments were able issue tax-exempt bonds to refinance traditional municipal debt prior to the call date. After Trump’s tax law was passed, municipalities could only use taxable bonds to advance refund outstanding tax-exempt debt. Many issuers didn’t take advantage of that route until August, when the numbers started to make more sense, said Barber.

JPMorgan municipal strategists said the taxable refundings are the “result of a low rate environment across the fixed-income markets,” the group led by Peter DeGroot wrote in a note published Friday. They expect such sales to continue and potentially increase in the fourth quarter.

The taxable bonds may provide investment opportunity for investors searching for yield or buyers who are indifferent to the tax-exemption, like those overseas where negative yields have become commonplace, DeGroot wrote. “The increased supply in taxable municipal bond resulting from tax-exempt advance refunding, may offer diversification and incremental yield relative to typical taxable fixed-income investments.”

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