The record-setting $900 million International Power Authority tax-exempt revenue issue dominated a market that was already facing a large new-issue calendar. The long IPA 2023 maturity alone was $580 million.
Buyers' appetite for the new issues was exceptional. The demand for the IPA issue was so strong that the underwriters increased the size of the issue by $102 million with the 2023 maturity being raised by $75 million.
The seemingly insatiable desire for this type of merchandise should come as no surprise. Over the past three years, the two largest buyers of municipals, for all practical purposes, have been absent from the market. Commercial banks, the traditional buyers of one- to 10-year bonds, have supplanted their need for tax-free bonds by their ability to make tax-free loans, by income from leasing deals and through income earned overseas.
Fire and casualty insurance companies, which historically have been the main buyers of long maturities, disappeared from the market in early 1980. This resulted from the huge underwriting losses incurred by these companies, which negated their need for tax-exempt income.
With the loss of such purchasers, an increase in the tax-exempt returns was necessary to attract new buyers. As yields rose, individuals picked up the slack--either through trust departments, unit investment trusts, open-end mutual funds or direct purchases. It is estimated that in 1981, 70 percent of the new issues were purchased by individuals, followed by a staggering 90 percent in 1982.
As the tax-free yields rose, the ratio of tax-exempt yields to taxable Treasury yields also reached new peaks. As a result, the tax exempts' yields became cheap, compared with taxables on a historical basis.
According to the Municipal Market Data Co. of Boston, prior to 1980 the usual ratio for yields of long A-rated electric revenue issues to those of long Treasuries was 75 percent. During the last two years, that ratio jumped to a high of 110 percent and has been averaging around 90 percent.
Because of the huge size of the IPA issue and some controversy concerning the project, the long bonds had to be priced to sell. Consequently, with a 10.50 percent rate of return, the ratio rose to 99 percent (10.50 10.59 percent). The bonds were simply too cheap for buyers to pass up.
The buyer of long municipals during the last two years stand to benefit from two directions--first, from the high rates themselves, and then from the price appreciation when the ratios move from the exceptional 90 percent area back towards the more usual 75 percent level.
This week the Treasury will offer three new issues--Tuesday a four-year note, Wednesday a seven-year note, and Thursday a 20-year bond. All will be available in minimums of $1,000 and should return 10.10 percent, 10.50 percent and 10.90 percent, respectively. These issues may be purchased at the Treasury in Washington or at any of the Federal Reserve Banks.