The volume of new municipal bonds with maturities longer than one year continues at a record pace. Through the first nine months of 1985, $90.8 billion have been issued. That compares with $58.6 billion during the similar period in 1984, and $101.9 billion for all of 1984. Revenue issues account for 6.6 percent of the 1985 volume.
There are several reasons for this outpouring of new municipals. First, recent legislation allowed each state to issue housing revenue bonds in the amount of $200 million per state, or $150 per capita, whichever is greater. States that have not issued their limit for the year are trying to do so by year-end. Second, the lower interest rates that have occurred in 1985 have led to a deluge of "advance refundings" of outstanding issues with high coupons prior to their maturities, at today's lower rates. These types of securities have totaled $2.6 billion, or 28.7 percent of the market so far in 1985.
Finally, the presence of the administration's tax-reform program before Congress has forced issuers of nongovernmental private-use bonds to flood the marketplace with their issues. Private-use tax-exempt bonds are those issues where the proceeds from the bond sale are made available for use by homeowners, private businesss, students and tax-exempt organizations. The elimination of this category of bonds could wipe out 60 percent to 70 percent of the new-issue market.
Two weeks ago, the House Ways and Means Committee presented an alternative tax-reform plan replete with proposals to remove much of the tax-exempt financing as the administration had proposed. The committee also set Jan. 1, 1986, as the effective date for the new legislation, regardless of when the legislation is passed. Quite naturally, all the tax-exempt issuers that stand to be eliminated by this legislation are planning to issue before Jan. 1, 1986. It is estimated that the new-issues, spurred on by the effective date, could result in volume of $12 billion per month, or $36 billion, for the last quarter of 1985. Obviously, dislocations will occur and, more than likely, interest rates on tax exempts will move higher. But is all of this issuing panic justified?
Capitol Hill sources have informed us that the chance of passage of a tax-reform bill this year is slim and even doubtful in 1986. They also point out that Congress passed legislation two years ago restricting the issuance of certain types of municipals, industrial development bonds, housing, etc., and so it would be almost impossible to single out municipals again and legislate against them. Further, the source stated that there were too many areas of disagreement in the legislation to form a consensus on the Ways and Means Committee. Items concerning lowering the maximum tax rate below 40 percent, and the elimination of state and local tax deductions by individuals from their federal taxes, were but two controversial items that were cited.
If a bill should emerge, problems were anticipated from the rules committee that indicated that amendments would be added to the bill that could force separate votes on different items and, in effect, force a loss of control to the bill's sponsors. Finally, the Capitol Hill source indicated that if it becomes obvious that a tax-reform bill could not be passed, a joint letter would be issued by Rep. Dan Rostenkowski (D-Ill) and Sen. Bob Packwood (R-Ore.) postponing the Jan. 1, 1986, effective date and assuring the markets that when and if tax-reform legislation is passed, it will not be retroactive. So it looks as if this issuing frenzie is being overdone and the issuers should settle down.
Regardless, the heavy volume has created attractive buying opportunities. Tax exempt yields are rising faster then taxable yields and the ratios of tax-exempt yields to taxable yields are in many instances close to or near their peaks for the year. For example, the 9.00 percent return on a 10-year A rated revenue issue is 86.3 percent of the taxable 10.25 percent return available on a 10-year Treasury. The highest ratio during the past year was 86.6 percent. At the same time, the return on a 30-year A rated revenue bond is 92.8 percent of the taxable yield on a 30-year Treasury (9.80 percent divided by 10.55 percent). The maximum ratio for the year is 96.4 percent. So take a good look at these opportunities before the issuers realize they could be over-reacting to the proposed tax-reform legislation.