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Bond redemptions hit record highs

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The 2017 spring and summer redemption season is expected to eclipse the previous record for called and maturing bond proceeds, freeing up an unprecedented amount of cash for new investment, municipal market sources said.

The three months starting in June are known for delivering the heaviest volume of called and maturing bonds in any given year. This year the annual occurrence is expected to be record-breaking, with over $100 billion of called and maturing bond proceeds — excluding coupon payments — slated to arrive into investors' accounts over the three-month span, according to proprietary data provided by municipal managers, analysts, and industry experts.

"We will basically have the most amount of money available to investors since day one of our business," Sean Duffy, managing director and head of municipal sales at Siebert Cisneros Shank, in New York, said in an interview last week. Siebert estimates the three-month volume of redemptions at $125 billion, which would beat the previous record for the three months set in 2015 when $117 billion in calls and maturities came due, he said.

The biggest monthly glut of redemptions will arrive in June when a minimum of $44.5 billion is expected to come due to investors from bonds called and maturing, followed by a minimum of $40 billion a month in both July and August, according to Duffy's figures.

This year's total consists of about $32 billion in called bonds and approximately $93 billion in maturing bonds, compared with the previous record in 2015 when $40.67 in called bonds and $76.52 billion in maturing bonds were redeemed from June through August, Siebert's data show.

It is difficult to predict what bonds will be refunded in the next three months, said Peter Delahunt, managing director of municipals at Raymond James. However, current and advanced refundings could increase reinvestment needs beyond what is already expected — as it did last year when $36 billion of bonds were currently called or refunded due to low interest rates between June and August. An additional $31 billion in bonds were also advance refunded, he said.

"There was a significant amount of monies needing to be re-invested [last year], and there will be again this year," Delahunt said.

Redemptions will grow to record numbers largely due to 10-year call provisions on that heavy issuance dating back to 2007, municipal experts said.

"2007 had a massive amount of issuance," as its $404.63 billion in total issuance held the record until last year when municipal issuance swelled to a record $417.30 billion, Duffy said.

The market has grown substantially in a decade as $167 billion in maturing bonds for all of 2007 pales in comparison to the $238 billion expected to mature in all of 2017, Duffy said.

"We are anticipating a rather strong redemption season in the months of June, July and August, with the ability for it to only increase were gross issuance not to pick-up as history suggests," Sean Carney of BlackRock said in an interview.

He estimated that $140 billion of maturities, calls, and coupon proceeds will return to investors — creating a net negative $35 billion in supply from June to August.

"Typically, gross issuance in June is 10% higher than what is produced in May, but elevated uncertainty coming from both the new Administration, as well as the Fed has changed these patterns to a degree," Carney said.

While June represents the first month in the upcoming string of significant redemptions and net-negative issuance months, performance usually does not follow until July, he said.

"June performance often suffers from an increase in gross issuance, which the market can initially struggle with, as well as a weaker seasonal pattern in overall interest rates," Carney explained.

The impact of a strong redemption season is most notable in the technicals of the municipal market, where supply and demand favor greater performance as there are just not enough bonds to go around, Carney said.

The state and local government debt market will shrink by an estimated $39.5 billion over June, July and August as bonds mature faster than they're issued, according to a Bloomberg report last week.

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While current heavy demand is keeping ratios tight between one and 10 years on the municipal curve, with continued demand expected to be very strong in the months ahead, "the problem is there is less supply than last year," Duffy said.

This year's volume estimates are lagging with approximately $92 billion expected to be issued in the three months from June to August this year, versus the comparable period last year when $108.19 billion in tax-free bonds were issued, according to Siebert figures.

The estimated $13 billion supply shortage will be felt by supply-hungry investors who decide to roll over their maturing and called bonds proceeds into the municipal market where there is already an imbalance of supply and demand, municipal experts said.

At the same time, those conditions create a potentially strong technical scenario for municipal outperformance as the historic redemption blitz nears.

Municipals are expected to "show continued outperformance" relative to U.S. Treasuries on strong technicals and waning tax-reform concerns, while retail and institutional demand should be more robust going forward, Jeffrey Lipton, managing director, head of municipal research and strategy and fixed income research at Oppenheimer wrote in a May 22 weekly municipal strategy report.

In an interview, Lipton elaborated on his report, saying that strong technicals and net negative supply figures are expected to expand into the summer months.

"For weeks now, we have been laying out the case for a strengthening technical profile as reinvestment demand from bond calls, coupon payments, and maturing securities is expected to surpass new issue volume," Lipton said.

He noted that June is expected to be a heavier reinvestment month as compared to July and August, and overall, this summer's reinvestment needs will exceed those of last summer.
"Much of this has to do with the near-record issuance of $429.9 billion in 2007, accounting for the 10-year call protection," Lipton explained.

Year-to-date, municipal supply trails the same period last year because of issuer concerns over tax-reform, Fed policy, and White House distractions, including the testimony of fired FBI director James Comey, according to Lipton.

"As prospects for near-term tax reform wane and expectations for less aggressive tax cuts expand, however, we believe that both retail and institutional demand will prove more robust against an enticing technical backdrop," Lipton said.

Some, like Duffy, said 2017 is proving to be one of the technically-strongest markets in five years.

Back in 2015, the impact of the previous record redemptions on the market caused the ratio of 30-year municipals to Treasuries to drop from 109.84% in June to 106.49% in August, according to Duffy's data.

Analysts largely believe the municipal market will outperform as June approaches.
"Over the summer months, we do not expect relative value ratios to present appreciably better opportunities given the likelihood of muni outperformance on technical strength," Lipton said.

Citing year to date Bloomberg/Barclays return data, municipals have earned 3.25%, outperforming Treasuries, which have returned 1.72%, he said.

The timing is ripe for outperformance with the backdrop of the heavy redemption season offset by the waning supply beginning June 1, according to a weekly municipal report on May 22 from Ramirez.

"We estimate that in June alone, about $86 billion will be available for reinvestment, including June 1 redemptions of $32 billion and coupon payments of $54 billion," versus a current 30-day visible supply of $11 billion, the report said. That leads to a total net supply shortfall of $75 billion, Ramirez estimates.

Ramirez forecasts that given the net market supply over the next 30 days, the municipal market is set to shrink by $21.56 billion — driven largely by redemptions from issuers in New York, California, Florida, New Jersey, and Georgia.

California and New York — two of the largest municipal issuers — will lead the nation with record redemptions, Duffy of Siebert said.

The Golden State will account for between $32.5 billion and $34.5 billion in called and maturing bonds over its upcoming redemption season, which runs for five months from May to September. The previous record for the highest California redemptions occurred over the same five-month period in 2013 when $30.27 billion came due, according to Duffy.

Meanwhile, New York will set a record for redemptions, with about $10 billion in called and maturing bonds coming due in June alone — replacing the prior record set in June 2015 of $7.5 billion, according to Siebert's figures.

Ramirez favors the California and New York markets because of their declining net supply, and also recommends the 15 to 20-year slope of the curve for the best value, given the "reasonable" ratios in the 90% range, according to the firm's report.

With all the redemption cash expected to flood investors' accounts, experts say there will be a significant volume of rollovers into municipal bonds even with concern over the potential for tax reform, which may dilute the value of the tax exemption, as investors hope to take advantage of current buying opportunities.

John Mousseau, executive vice president and director of fixed income at Cumberland Advisors, predicted there will be a robust redemption season beginning in June — despite some "leakage" into stocks.

“The equity markets drew a fair amount of principle and interest redemptions away from the bond market, and we saw the 10-year municipal to Treasury ratio cheapen from 85% in mid-May to 95% in early August” of 2016, Delahunt of Raymond James said.

“Currently, the 10-year municipal to Treasury ratio is rich again, at 88%, however, the equity market is at its highs,” he said. “The Dow is up about 10% from last year at this time and the S&P closer to 15%, so the muni market is in a little better relative perspective to capture a fair share of the re-investment proceeds.”

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