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Municipal Perspective published on December 7, 2017

Municipal Market Supply: A Q&A with CIO David Madigan

In the wake of a significant increase in municipal supply, Breckinridge’s marketing team asked David Madigan, Breckinridge chief investment officer, to discuss the trend and what it means for municipal investors.

Q: Municipal supply has been running very high. About $20 billion is on the calendar this week,1 which is one of the heaviest weekly calendars on record. Why is this happening?

A: Municipal new issue supply has been accelerated since early November, when the House passed its tax reform bill. That bill included provisions to eliminate private activity bonds (PABs) and advance refunding bonds. The Senate bill, passed last weekend, also eliminates advance refunding bonds, but allows PABs.

Issuers are responding by pulling forward supply and issuing bonds before year-end, to dodge uncertainties next year and to have PABs and advance refunding bonds that will be “grandfathered” following tax reform’s expected January 1 effective date.

For example, toward the end of November, the New York Metropolitan Transportation Authority issued advance refunding green bonds at a total size of $2.2 billion, which was upsized from an initial $600 million. Since then, deals have also been scheduled in the University, Transportation and Hospital sectors, as examples.

Q: Refunding issuance has already been on a declining trend; year-to-date, refunding supply is down 37 percent. What could the elimination of advance refunding issuance mean for future supply?

A: Overall, we expect municipal supply in early 2018 to be lower due to the pull-forward of supply and the elimination of advance refunding. In 2016, advance refunding bonds made up between 25 and 30 percent of total issuance, per Citi estimates.2 While new money issuance has risen modestly year-to-date (up 6 percent), we do not believe that future new money issuance from essential service bonds – which remain tax-exempt – will make up for this shortfall of supply.

That said, the tax reform bill is currently headed for a conference committee to reconcile the Senate and House proposals. The tax situation is fluid and the outcome of the committee may greatly affect the impact of these changes.

Q: How has this surge in new supply been received by markets so far?

A: The new issues have been largely oversubscribed. Most negotiated issues are seeing orders of between four and 10 times the available volume. This, along with strong investor flows into municipal bonds, indicates that investors recognize this time as an opportunity to buy municipal bonds – before anticipated lower issuance new year.

Q: With this strong demand, how is Breckinridge taking advantage of opportunities to participate in deals – particularly those that meet our strict credit standards and balance risk and return?

A: We are placing new issue orders, but continue to work through the secondary market as well. Part of the impact of new issue activity is that it drives more “bid lists” of bonds – lists of bonds to be sold in the secondary market – to pay for new investments. We have always been active in bidding bonds in the secondary market, because these transactions help to reduce transaction costs.

Still, we are currently much more focused on primary markets given the strong supply. This is a change from the summer months, when issuance was much lighter and we were much more focused on secondary market trading. We believe our strong capabilities to source bonds in both primary and secondary markets have allowed us to be flexible and find bonds for client portfolios. For more information on our trading capabilities, please see our blog post, Trading Effectively in an Inefficient Municipal Market.

Q: To wrap up, where do municipal/Treasury ratios currently stand, and what opportunities could these important supply trends create for investors?

A: Prices have increased more than 2 percent over the past five days – the largest five-day gain since 2011, per MMA. So, there is certainly momentum, and demand for muni bonds is very strong given expectations for the technical backdrop, as previously discussed. Nonetheless, we think there are some compelling opportunities to purchase bonds before supply is lowered. As of December 6, ratios from two to 5 years are more attractive than they have been in recent months, at a range of 75-79 percent. This is an upward shift from the recent 61-66 percent range in two- to five-year ratios seen in September and October. Much of the rise in shorter ratios is due to the hefty supply of new issue bonds. Investors are also looking for bids on shorter paper to raise cash to go into new deals in the primary market.

We expect that as supply falls off after year-end, municipal ratios will fall back to their year-to-date averages for short maturities (i.e., 70-75 percent). Although these ratios are lower than average since the financial crisis, they are in line with historic yield ratios from 1985 to 2005 (the five-year average is 76 percent for this period).


[1] Breckinridge Capital Advisors, as of December 7, 2017.

[2] Citi and the Bond Buyer, as of November 6, 2017.


DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.

Some information has been taken directly from unaffiliated third party sources. Breckinridge believes such information is reliable, but does not guarantee its accuracy or completeness.

Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.