Investment opportunities in the taxable municipal bond market may also arise for investors as taxable issuance is up over 50% this year versus the first two months of 2012.
“Taxable munis are definitely attractive,” said Eric Friedland, head of muni research at Schroders Investment Management, adding the firm’s U.S. taxable fixed-income groups are paying attention to them. “They have incrementally increased allocations to taxable municipal bonds this year and are bringing taxable munis into other non-U.S. portfolios in the firm.”
He said one reason why many firms are adding strategic allocations to taxable munis is that there is more recent issuance.
“There are situations where universities and municipalities are using taxable bonds to refund tax-exempts because there are restrictions on how any times an issuer can refund tax-exempts, but there aren’t restrictions on taxable refunding.”
With rates so low, issuing taxable municipal bonds makes sense in this environment, Friedland said, adding: “Absolute and relative rates are so low that the economic benefits of refunding tax-exempts with taxables outweighs the costs.”
Yields on triple-A taxable munis have jumped so far this year, according to the Municipal Market Data scale. The five-year yield increased to 1.15% on March 1 from 1.03% on Jan. 2.
The five-year yield hit its highest on Jan. 31 at 1.35%. The 10-year triple-A taxable yield increased to 2.46% from 2.41% at the beginning of the year. It hit its highest of point the year at 2.63% on Feb. 19. Similarly, the 30-year yield jumped to 3.83% from 3.80% at the start of 2013. It hit its highest of the year at 3.99% on Feb. 19.
Triple-B taxable munis have also seen a small selloff. The two-year jumped to 2.44% on March 1 from 2.38% at the start of 2013. The five-year yield jumped to 3.40% on March 1 from 3.29% at the beginning of the year. To be sure, yields on the long end have rallied. The 10-year triple-B taxable muni yield fell to 4.79% from 5.06%, while the 30-year fell to 5.87% from 6.05% at the start of the year.
Yields on other taxable asset classes have risen as well, though not as much as taxable muni yields, allowing the spread to widen.
The spread between the two-year taxable triple-A MMD yield and the two-year Treasury widened to 25 basis points on March 1 from 14 basis points on Jan. 2. Similarly, the five-year triple-A taxable MMD yield and the five-year Treasury widened to 40 basis points from 27 basis points at the beginning of the year. Similarly, the 10-year spread widened to 61 basis points from 57. The 30-year spread widened just slightly to 77 from 75 basis points.
Further down in credit quality, the spread between the two-year triple-B taxable MMD yield and the corresponding Treasury yield widened to 220 basis points from 212. The five-year spread widened to 265 basis points from 253 at the beginning of the year.
Spreads on the long-end have compressed as investors move out in duration in search for yield. The spread between the 10-year triple-B taxable MMD yield and the corresponding Treasury yield compressed to 294 basis points from 322 basis points. The 30-year triple-B taxable MMD yield and the corresponding Treasury yield compressed to 281 basis points from 300 at the beginning of the year.
Taxable munis also look attractive relative to corporate bonds as spreads have widened over the course of January. “The way corporate spreads have tightened over last six months to a year, taxable munis are still offering attractive opportunities on a relative basis,” said Peyton Studebaker, vice president at Caprin Asset Management.
He added that taxable munis look attractive on a comparable rating basis. “If you look at a double-A-rated county GO deal in a state like Virginia that was issued on the taxable side versus a double-A-rated corporate bond, you can pick up 15 to 20 basis points in the front-end of the curve,” he said.
Spreads between the two-year triple-A MMD taxable muni and the two-year triple-A corporate bond widened to negative one basis point on March 1 from negative 18 basis points at the start of 2013. The five-year spread widened to negative one basis point from negative 14 basis points on Jan. 2. Similarly, the 10-year spread widened to negative one basis point from negative 21 basis points at the start of the year.
Moving down the credit scale, triple-B taxable munis look even more attractive relative to triple-B corporates. Spreads on the two-year widened to 84 basis points on March 1 from 65 on Jan. 2. The five-year spread opened up to 70 basis points from 44 basis points.
To be sure, spreads on the long end have compressed. The spread between the 10-year triple-B taxable MMD yield and the triple-B corporate compressed to 68 basis points from 101 basis points. The spread between the 25-year triple-B taxable MMD yield and the 25-year triple-B corporate yield tightened to 36 basis points from 84 basis points.
