Did munis lose their shine, or are they an ideal investment for our times?
Has supply cratered, or will the market expand?
If you’re an investor following the twists and turns of the municipal bond market, you’ve noticed a lot of headlines lately dedicated to the normally staid securities.
With the tax overhaul, a drop in issuance and a presidential administration intent on attracting private funds to help finance its infrastructure ambitions, there’s plenty of material to fuel a profusion of financial headlines.
But for individual investors following the day-to-day machinations, it’s not so easy. They’re forced to sort through the conflicting prognostications and decide which storyline makes sense. It’s tough, as each argument has at least a kernel of truth.
More, or less, municipal bonds
Consider the tax overhaul. Its centerpiece was a reduction in corporate taxes. In theory, this should cool demand for tax-free bonds by big institutional investors, such as banks and insurance companies, which could affect individual investors.
Yet the tax plan also put a crimp in the supply of munis. Advance refunding bonds, which enable issuers to refinance their debt to lower borrowing costs, were disallowed. They accounted for about 30% of the muni supply.
Had the House had its way and disallowed private activity bonds, too, the market would’ve contracted further. But PABs, which account for approximately 20% of the overall muni market, made it through the final bill unscathed.
In fact, the Trump administration now wants to expand use of PABs. Currently, they fund projects such as airports, toll roads and affordable housing. As we pointed out (“Washington Rethinking Its Position on Municipal Bonds”), the administration wants to allow them to be used for more privately financed infrastructure, such as hydroelectric power generation facilities.
Further, a bill working its way through Congress aimed at easing some banking regulations includes a provision that would make it easier for large banks to buy state and local bonds.
New banking bill would deem munis ‘high quality’
It’s been a contentious issue for years (“House Votes to Treat Munis As ‘High Quality’ in Bank Rule”): New banking rules, approved in the wake of the 2008 fiscal emergency, excluded municipal bonds as “high-quality liquid assets” that could be held to satisfy new liquidity requirements.
The rule was panned by many as unnecessarily raising costs for public projects as well as detrimental to investors.
The bill to reverse it could be taken up by the full Senate this week.
Meantime, at the end of last year, while the new tax legislation was being debated, issuers, fearful of the uncertainty, went on a tear, issuing a gusher of bonds. Since the beginning of the year, however, the pace has slowed considerably, as observers expected.
As a veteran of the bond market, it’s hard to imagine how an average investor can make sense of all the headlines. We don’t even try.
Fact is, successful, long-term municipal bond investors ignore the day-to-day cacophony. Generating a predictable stream of tax-free income is their goal, and that doesn’t lend itself to an investment style dependent on the latest headlines. The big picture is what’s important.
Municipal bonds serve an important purpose for both investors and issuers. It was interesting, though not surprising, that even during the mass issuance at the end of 2017, investors weren’t sated.
Instead of trying to anticipate and decipher the next sound bite, muni investors are better served looking forward to their next interest payment.