The Fisc

Sun. Sand. And Shark Week.

As millions of people enjoy the beach during summer vacation, Discovery Channel delivers its annual reminder that many things – some potentially harmful, and some just downright scary – may lie beneath the surface. It’s a good analogy for municipal bond issuers when it comes to current and future interest rates.

Two weeks ago, Heather Gillers wrote a great article in The Wall Street Journal on how attractive interest rates are right now for bond market issuers. You can read it here. She’s right. The 30-year borrowing rates remain at or slightly below 3% according to the Thomson Reuters MMD scale. By contrast, 30-year mortgage rates are 4.625%, roughly 160 basis points higher. Issuers should take advantage on the continued low interest rates for as long as they last.

Heather’s article also pointed out one of the big reasons why this is occurring: the supply of new bonds in 2018 is significantly lower due to some accelerated 2017 borrowing. Through mid-year, supply is down 17% year-over-year, and Citigroup is expecting that the 2018 total issuance number will be 25% lower than in 2017. Supply is so low that net supply, the amount of new bonds being issued compared with outstanding bonds maturing, has been negative. This has led to an environment in which investors are grabbing for bonds and driving down interest rates.

So, on the surface, the bond market – like ocean waters – appears placid and safe. But what’s below the surface? Are dangers lurking that issuers should keep in mind?

Yes.

The primary driver of current interest rates is lack of supply. It’s masking other rip currents in the market that lie unseen below the surface. To wit, major traditional buyers of munis have stopped buying in 2018 because of new tax code changes. In other articles, Amanda Albright of Bloomberg noted that property & casualty insurers have stopped buying munis. According to Fed data, these buyers currently hold over $340 billion in tax-exempt bonds. Bloomberg’s Michelle Kaske reported that major Wall Street banks have stopped buying munis for the first time since 2009.

The key takeaway for issuers is that there are risks in the municipal bond market. There is likely a higher cost of capital lurking beneath the surface. We’ll probably see it when supply of new-issue bonds in the market reverts to traditional levels. In other words, issuers should beware the unseen “swimming sharks” and other potential dangers. You may never get bit, but isn’t avoiding an injury preferable to surviving one? Issuers can and should remain mindful of hidden dangers and take smart action to ensure their future debt financing is a success.