Such A Demanding Muni Market!

by Jeffrey Lipton January 21, 2020

Traditional and non-traditional muni investors have grown comfortable with the wave of taxable issuance that drove 2019 aggregate volume to one of the highest volumes on record

Even with ample demand throughout 2019, the availability of deployable cash remains heavy and this backdrop will likely be the case through at least the first half of 2020. Issuers have found muni religion and realize the value of today’s low cost of funding for both new money and refunding transactions. Such outsized demand comes with a higher price tag, with current relative value ratios for the 10 and 30-year benchmarks at 73% and 86% respectively. Ratios are now back to where they were at the end of July, with investors lacking any indication of sticker shock. If our analysts see a let-up in issuance and if demand holds steady, then it is logical to say that munis can become even more expensive.

Taxable munis offer a viable proxy for tax-efficient accounts such as IRAs, with availability for incremental yield. Although spreads tend to be credit-specific, 20-year taxable munis generally trade at a spread of about 80-90 basis points to U.S. 30-Year Treasury (UST 30) and 15-year taxable munis trade at a spread of about 100-110 basis points to U.S. 10-Year Treasury (UST 10). Another area to pick up a yield advantage can be found with Alternative Minimum Tax (AMT) muni bonds. Changes made under the Tax Cuts and Jobs Act will effectively lower the number of AMT taxpayers by a substantial amount, thus creating opportunity for those investors not subject to AMT. The spread between an “A” rated AMT revenue bond due in 20 years and a comparable maturity and rating non-AMT bond is about 30 basis points.

Reiterating a theme from last year, muni portfolio additions and realignment should be made with a disciplined eye toward quality and resiliency, as muni credit is plateauing. Adherence to suitability needs and investment guidelines should position portfolios defensively to mitigate potential shocks during the next downturn. Such posturing helps to avoid jeopardizing portfolio returns, credit quality, liquidity, cash flow and diversification. The presence of a compressed spread environment could help facilitate an upgrade in portfolio credit quality.

For a comprehensive portfolio evaluation of your municipal holdings, please contact your Oppenheimer Financial Advisor.

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