First Quarter 2009 Tax-Exempt Muni Bond Market Review
April 15, 2009
Author(s):
First Quarter 2009 Fixed Income Sector Returns (Pre-Tax)*
First Quarter 2009 Fixed Income Return Per Unit of Duration*
*As of 03/31/09. Source: Barclays Capital
The municipal market began the quarter with tremendous exuberance following the municipal/ treasury ratios entering into the year at historically wide levels. Mutual fund flows returned positive, retail investors increased their demand and crossover buyers were more attracted to these historically high ratios. This momentum continued through the middle of February, until concerns about increased supply combined with low yields and tightened ratios caused investors to pause. As the market has transitioned from the leverage buyer as the major investor of the sector to the retail investor, the market has become much more sensitive to expectations of increased supply. While year-to-date issuance, through the end of March, is flat when compared to issuance during the first quarter of 2008, there was a 50% increase from February’s issuance to March. Improved market conditions and continued low yields enabled issuers to more readily access the market.
The potential for increased issuance continues to weigh on the market, but there are a number of favorable factors that are also positively affecting the municipal sector. While details continue to be released from Washington regarding economic stimulus, current Federal support of municipalities appears strong. The first deals of the “Build America Bond Program” are expected to be issued shortly. Under this Federal program, issuers will receive incentives to issue in the taxable market through a tax credit of 35%, where the Federal Government will offset a portion of the interest cost, lowering their net borrowing costs. This program will be in effect only for bonds issued in 2009 or 2010 as taxable municipal debt, and is designed to broaden the investor base, opening it up to the more traditional corporate buyer. As long as the net borrowing costs are lower under this program, the municipalities are expected to benefit. Issuance under this program is expected to exceed $100 billion over the next two years, but because it will be issued as taxable debt, this may lessen the amount of tax-exempt issuance with issuers favoring this opportunity.
The Build America Bond program and other proposed stimulus efforts are greatly needed as municipalities continue to struggle in this economic challenged time. Municipalities continue to struggle with lower tax receipts as a result of the housing market collapse, higher unemployment and decreased consumer spending. The House Financial Services Committee is drafting proposals to facilitate municipal issuers to more readily access the debt market through the use of federal guarantees and a federal reinsurance program allowing monoline insurers to underwrite new business. Despite these efforts, Moody’s has assigned a negative outlook to the U.S. local government sector, reflecting significant fiscal challenges. While this will likely affect the overall liquidity for the sector in the short-term, the historic default rates for municipals remain extremely low even during economically adverse times.
Past performance is no guarantee of future results. Indices are not available for direct investment. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.
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