Wealthy residents in high-tax U.S. states are just starting to feel the pain in the pocketbook caused by the 2017 Tax Cuts and Jobs Act.
And that big tax bill, in turn, is reminding investors of the intrinsic value that munis can have on their portfolios.
For the ninth week in a row, cash rushed into municipal bond funds, according to data from Refinitiv Lipper released late Thursday.
“The year-to-date inflows into municipal bond funds total $14 billion,” said John Malloy, senior municipal bond portfolio manager at Wilmington Trust. “This is the best start to a year since they began collecting this data.”
Malloy cited the just-now-being-felt effects of the tax act’s $10,000 cap on state and local tax deductions. “This investors in high-tax states such as New York, New Jersey, Connecticut and California are filing their tax returns right now,” he said. “And this is making municipal bonds a compelling choice for retail investors.”
Malloy pointed to the recent California $2.3 billion general obligation bond deal as showing the strong demand for tax-exempt paper. “There were about $7 billion in orders for that deal,” he said, adding it later traded eight to 10 basis points better in the 10- to 15-year part of the curve.
“There is a lot of cash coming into our market right now,” he said.
Anthony Tanner, senior vice president at Aquila Investment Management, said SALT has both made tax considerations more complicated and increased tax bills for investors – two things they do not like.
Tanner, who is also lead manager of the Aquila Tax-Free Trust of Arizona, said this has illuminated and brought a newfound appreciation for the value of the tax-exemption and recent inflow trends in the municipal bond asset class likely reflect this.
He said the tax changes also sparked a renewed appreciation for professional management of the funds that can help retail navigate a more complicated and difficult tax landscape.
He added that with some of the tax hike rhetoric coming out of Washington, it’s likely that the tax-exemption and the municipal bond class will only become more popular.
“This serves as a reminder that muni bonds are the blue jeans of the asset allocation closet -- never the height of fashion, but always in style,” Tanner said.
Investors seeking relief from SALT cuts are significantly supportive of this week’s inflows, according to Chris Brigati, head of municipal trading at Advisors Asset Management.
“An out-sized amount of investment appears to be flowing into the tax-exempt bond market including mutual funds,” Brigati said, noting that investors in high tax states like New York, New Jersey, and California are in particular need of shelter from future tax bills.
Ron Alberts, senior vice president of fixed-income strategies at the Johnson Financial group agreed the tax changes were helping push inflows.
“Clearly the word got out to more investors that purchasing tax-exempt municipal bonds is a way to reduce taxable income going forward, a chief consideration for people finding themselves affected by the SALT cap in the tax bill,” Alberts said.
Robert Amodeo, head of municipals at Western Asset Management in Pasadena, said there were a variety of reasons that muni funds were doing so well now.
“The upbeat investment atmosphere in the municipal market stems from a few factors including a quiet new-issue calendar, steady fundamental backdrop, and solid demand from SMA accounts and open-end mutual funds,” Amodeo said. “Frankly, investors are not seeing a fundamental justification for avoiding munis. Investors also appear to be depositing proceeds into municipal bonds when rebalancing their investments given municipal income is more valuable as the Tax Cuts and Jobs Act provides investors with fewer options to avoid paying income taxes. Proposals for increased income tax rates in states such as New Jersey and Illinois make tax-exemption more attractive to investors, too.“
Amodeo was upbeat about the future.
“Looking ahead, we are encouraged by the steady fundamentals in the muni market due to a number of factors, including low unemployment, and stable tax revenues,” he said. “However, if there are near-term risks to valuations they likely will surface due to less favorable technicals, including lackluster mutual fund flows. We expect recent steady demand from SMA accounts and mutual funds to remain in place at least until tax payment time.”
Jason Escamilla, CEO of Impact Labs, said “municipal bond funds in a high-tax state like California are relatively more desirable after tax reform. This is because marginal tax rates can be higher and fewer people get hit with AMT after tax reform.”
He cited this example: “Married, two kids; $430,000 of income, no deductions and you keep less than 48 cents on the dollar in money market interest/dividends. And don’t forget about the Fed’s 2% inflation target over time: expect a 2% inflation hit,” he said. “A higher-yielding 2.5% money market fund rate does not even beat inflation once you get into a meaningful tax rate -- e.g. making enough to cover the cost of a family today. Even in an IRA, you eventually have to pay the tax man in nearly all scenarios.”
"When you’re looking to park taxable cash, there are smarter places than a money market fund,” he said, noting how meaningful it was to avoid standard interest tax rates in California and other high-tax states.
Brigati said that besides the tax reform, market technicals are boosting demand in the current market, he said. Lower relative yields and tighter credit spreads for bonds issued within high-tax states provides additional evidence of the strong demand for municipal securities, he said.
In addition, the ratio of municipal bonds as a percentage of the comparable Treasury bonds are aggressive on an historical basis — and that is also sustaining the hearty municipal demand and resulting fund flows.
Brigati pointed to lower ratios as good indicators of strong demand for tax-exempt municipal bonds in the first quarter of 2019 as compared to higher ratios last year at the same time. Specifically, he noted that 10-year ratios were about 86% in 2018 over the same time frame, as compared to the currently ratio of 76%.
“The long-term average for 10-year municipal ratios is around the 85% level, indicating the current demand to be strong on an historical basis,” Brigati said.
He said the current demand patters should continue as the April 15 tax deadline passes and more investors in states most influenced by the change in SALT deductions observe the actual impact to their individual circumstances. "Any relief from the current SALT deduction framework could provide some slowdown to this flow,” Brigati said. “Most tax policy experts, however, indicate that such an outcome is very unlikely in the near future.,”
“At this point in time, I cannot foresee any catalyst that could provide a reason for these strong flows to change,” he added.
Looking at the data, Lipper said the weekly reporting mutual funds had $797.501 million of inflows in the week ended March 6 after seeing inflows of $1.705 billion in the previous week. Exchange traded muni funds reported inflows of $84.664 million after inflows of $144.400 million in the previous week. Ex-ETFs, muni funds saw inflows of $712.837 million after inflows of $1.560 billion in the previous week.
The four-week moving average remained positive at $1.355 billion, after being in the green at $1.444 billion in the previous week.
Long-term muni bond funds had inflows of $372.940 million in the latest week after inflows of $1.110 billion in the previous week. Intermediate-term funds had inflows of $350.599 million after inflows of $469.295 million in the prior week. National funds had inflows of $670.193 million after inflows of $1.515 billion in the previous week. High-yield muni funds reported inflows of $373.681 million in the latest week, after inflows of $472.731 million the previous week.
On Wednesday, the Investment Company Institute reported that long-term municipal bond funds and exchange-traded funds saw a combined inflow of $2.626 billion in the week ended Feb. 27. This followed an inflow of $2.472 billion from the tax-exempt mutual funds in the week ended Feb. 20. Long-term muni funds alone saw an inflow of $2.440 billion after an inflow of $2.351 billion in the previous week while ETF muni funds saw an inflow of $186 million after an inflow of $121 million in the prior week.
Looking short-term, the Money Fund Report reported Wednesday tax-free municipal money market fund assets increased $1.26 billion to $139.46 billion in the week ended March 4.
Primary market
Municipal bond buyers are looking forward to more supply in the upcoming week. IHS Markit Ipreo forecasts weekly bond volume will increase to $5.5 billion from a revised total of $4.5 billion in the prior week, according to updated data from Refinitiv. The calendar is composed of $4.0 billion of negotiated deals and $1.5 billion of competitive sales.
Topping the calendar is a $654 million deal from the Regents of the University of California (Aa2/AA/AA). UBS Financial Services will price the general revenue Series 2019 BB tax-exempts and Series 2019 BC & BD taxable on Tuesday.
Also on tap is a $370 million deal from the Lower Colorado River Authority (/A/A-plus) in Texas. Citigroup is set to price the contract refunding revenue bonds for the LCRA Transmission Services Corp. on Wednesday.
In the competitive market, New York State is selling $115.69 million of Series 2019A tax-exempt new-money transportation, education and environmental purposes general obligation bonds on Wednesday. The financial advisor is Public Resources Advisory Group.
In the short-term market, the New York Metropolitan Transportation Authority (//F1+) is competitively selling $750 million of Series 2019A dedicated tax fund bond anticipation notes on Tuesday. The financial advisors are PRAG and Backstrom McCarley Berry. The bond counsel are Nixon Peabody and D. Seaton & Associates.
Bond Buyer 30-day visible supply at $7.08B
The supply calendar rose $151.2 million to $7.08 billion for Monday, composed of $2.81 billion of competitive sales and $4.27 billion of negotiated deals.
Secondary market
Municipal bonds were stronger on Friday, according to the MBIS benchmark scale, with muni yields falling one basis point in the 10-year maturity and two basis points in the 30-year maturity. High-grade munis were also stronger, with yields falling one basis point in the 10-year maturity and two basis points in the 30-year maturity.
Investment-grade municipals were stronger on Refinitiv Municipal Market Data’s AAA benchmark scale, which showed the yield on the 10-year muni falling two basis points while the yield on the 30-year muni dropping three basis points.
Treasuries were stronger while equities declined.
The 10-year muni-to-Treasury ratio was calculated at 78.6% while the 30-year muni-to-Treasury ratio stood at 96.1%, according to MMD.
“The ICE Muni Yield Curve is rallying along with Treasuries today; yields are a much as two basis points lower in the long end,” ICE Data Services said in a market comment. “High-yield issues are a basis point better in general.”
Previous session's activity
The MSRB reported 42,850 trades on Thursday on $18.068 billion of volume. California, New York and Texas were most traded, with the Golden State taking 18.466% of the market, the Empire State taking 12.624% and the Lone Star State taking 11.126%
Week's actively traded issues
Some of the most actively traded munis by type in the week ended March 8 were from California and Puerto Rico issuers, according to
In the GO bond sector, the California 5s of 2049 traded 72 times. In the revenue bond sector, the Puerto Rico Sales Tax Financing Corp. 5s of 2058 traded 49 times. In the taxable bond sector, the Puerto Rico GDB Dent Recovery Authority 7.5s of 2040 traded 32 times.
Week's actively quoted issues
Puerto Rico and Massachusetts names were among the most actively quoted bonds in the week ended March 8, according to IHS Markit.
On the bid side, the COFINA revenue 5s of 2058 were quoted by 257 unique dealers. On the ask side, the Massachusetts Development Finance Agency revenue 5.25s of 2041 were quoted by 316 dealers. Among two-sided quotes, the COFINA revenue 5s of 2058 were quoted by 55 dealers.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation.
