So far in 1985, the issuance of new municipal bonds with maturities longer than one year has been running at record rates. Through the end of August, $79 billion of the tax-free issues had been issued. That compares with $49.8 billion sold through the first eight months of 1984, the previous record year.
Question: Why such an outpouring of new municipals? Answer: Issuers perceive that the passage of the administration's tax reform program will curtail the number of present bond issuers, which, in turn, will reduce the amount of new tax-exempt bonds that will be issued each year. Also, the decline in interest rates has led to the refunding of many outstanding issues that had been issued earlier with much higher interest rates.
On the flip side of the coin, we see that not only are individuals continuing to purchase "tax frees" either directly or through trust departments, mutual funds or unit investment trusts, but that old friends -- commercial banks and fire and casualty insurance companies -- have returned as good buyers of municipals.
Question: Why have these traditional buyers been so anxious to scoop up the record-setting supply of new issues? Answer: First, tax considerations have changed for fire and casualty insurance companies and they now have income to shelter. Second, the overall concern that the passage of the administration's tax reform program will a) lower tax exempt yields because of reduced supply and b) reduce the advantages for commercial banks and fire and casualty companies for owning municipal bonds. Third, on a relative basis, owning tax frees has been attractive when compared with the after-tax returns on comparable Treasury maturities.
Recently, several congressional leaders, when questioned about the possibility of the passage of the administration's tax reform legislation, have strongly indicated that there is no hope for passage in 1985 and that in 1986, being an election year, there is at best only a 50-50 chance of passage of any meaningful program. Some Hill watchers feel that even if a program is passed in 1986, it will be very different from currently proposed legislation.
Question: If the actual passage of the tax reform program is so nebulous, why then the continued frenzy in both the issuing and purchasing of municipal bonds? Another question: If the passage of tax reform legislation is so remote, why does not the municipal bond market give up ground under the weight of the new issues, and why, therefore, do not tax-exempt yields rise even farther? Answer: First, buyers perceive that the ratios of tax-exempt returns to taxable bonds have been and continue to be attractive, so they continue to purchase tax frees. Next, for both issuers and buyers, there is always the fear that some type of legislation could be introduced that could be retroactive and have the same effect as having actually been passed. Whatever the reasons, the flood of new issues will continue for the rest of this year, and it remains to be seen how responsive buyers will be, and also, if tax-exempt rates will move higher.
Incidently, during the the next two weeks, $1.1 billion of state general obligation bonds will be marketed. They include Louisiana, Minnesota, Massachusetts, California, New York, Washington and Oregon. Although these names do not have the highest credit ratings of the high-grade sector, they could prove inviting to state name buyers as they will probably offer a little more yield than usual and also because yields on general obligation issues are attractive against revenue tax exempts and taxable Treasuries as well. They will be worth following.