Municipal market analysts and portfolio managers anticipate that the reinvestment of July 1 payments to municipal bond investors could pour as much as $37 billion into the tax-exempt market in the next few weeks.
A large portion of the cash is expected to flow from a record number of bonds being called, or redeemed prior to maturity, on July 1. More money would come from semi-annual interest payments and bonds maturing on July 1.
Investors were slapped with the first big wave of redemptions on July 1, 1992, when about $6 billion of bonds were called.
The rise in redemptions reflects the growth in long-term, new-issue volume a decade ago, when interest rates began peaking, analysts say. Redemptions are expected to grow through 1995, mirroring 1985's record $228.8 billion volume.
The 1985 record was broken last October. As a result, investors should brace themselves for further redemption onslaughts, analysts say.
"People feel they've been hit once, but they're not going to be hit this year. There's really going to be a rolling barrage," said James J. Cooner, senior vice president and manager of the tax-exempt division at the Bank of New York. "I think this market is going to be awash with cash."
According to Muniview, a Bond Buyer database, approximately $10.4 billion of bonds are expected to be called on July 1. This includes advanced refunded bonds, as well as issues with a first call date of July 1 and bonds escrowed to maturity on that date. In addition, $9.2 billion of bonds are scheduled to mature then.
And another $48.5 billion of bonds are eligible for redemption on July 1. That figure includes bonds with an optional call that falls on that date.
In comparison, approximately $6 billion of bonds were redeemed last July and $9.8 billion of bonds were called on Jan. 1 of this year.
The average coupon rate of bonds expected to be redeemed on July 1 is 7.12%, according to MuniView.
The approximately $10 billion of bond redemptions expected on July 1 should be about 20% higher than in previous years, said George D. Friedlander, a managing director and fixed-income strategist at Smith Barney, Harris Upham & Co.
Up From the Past
"The largest bond call date is 10 years after the bonds are issued." Friedlander said. According to the Smith Barney strategist, volume in the second and third quarters of 1983 was 20% higher than during the same period in 1982. And the first optional call date for those 1983 issues is July 1 of this year, he said.
Friedlander also anticipates investors could receive about $20 billion in coupon payments on July 1.
He said he determined this number based on the fact there are approximately $1.1 trillion of tax-exempt bonds outstanding. The majority of these bonds have an average coupon rate of 7%. Friedlander said.
With $1.1 trillion of bonds with an average 7% coupon rate, the annual interest payments would total about $77 billion, or $38.5 billion paid semi-annually, Freidlander calculated.
While Jan. 1 and July 1 are historically the largest interest payment dates, not all interest is paid on those days, Friedlander said. To allow for this, he used a little more than half of the $38.5 billion, or $20 billion, to reach his coupon estimate for July 1.
Patricia M. Dolan, a managing director in the municipal bond division at Prudential Investment Corp., a subsidiary of the Prudential Insurance Co., expects July 1 cash to total slightly more than $36 billion. While about $10 billion of that has already been reinvested in the tax-exempt market, the other $26.6 billion is forthcoming, she said.
Dolan estimates that about $19 billion of that will come from households, about $2 billion to $2.5 billion from mutual funds, and $5 billion from property and casualty insurers.
Banks may receive about $4 billion in July 1 payments, but most or none of that will flow back into municipals, Dolan said. In part due to federal restrictions and limitations on bank investments in municipals, most banks are simply letting municipal bonds in their portfolios mature and reinvesting the cash elsehwere.
Although refunding volume has made up the bulk of new issuance in 1993, there are still bonds outstanding that make good candidates for redemption, Bank of New York's Cooner said.
Cooner bases his estimates on an examination of yields on The Bond Buyer's 20-bond Index of 10 years ago to the present.
For the week ended June 17, the 20-bond index yielded 5.61%. At its lowest level in 1983, the index yielded 8.78%. It was at 9.51% at its lowest point in 1984, and at 8.37% at its lowest level in 1985.
"These are the lowest numbers. The highest numbers were double-digit." Cooner said. "Looking at the lowest numbers for 1983 through 1985, we have spreads that are hundreds of basis points away from where the index is now."
Such wide spreads give issuers plenty of room to consider calling outstanding bonds and issuer debt with lower yields, he said.
Ready for the Flood
Most fund managers believe the market is prepared for the cash deluge.
"I wouldn't expect some major pop in the municipal market just because it's July 1," said Robert S. Dow. a partner and head of fixed-income management for Lord Abbett & Co.
Dow said he expects mutual fund sales to increase shortly after July 1, as individuals who have bonds called away from them find it increasingly difficult to replace those securities.
"Retall buying interest has started." said Triet Nguyen, a senior vice president and portfolio manager for Putnam Investments. "Brokerage firms are drumming up interest a little ahead of time."
Merrill Lynch & Co. has seen possibly a record number of retail orders for bonds in the past week, with orders totaling approximately $300 million to $400 million, according to several market sources.
Merrill Lynch officials could not be reached for comment
Anticipated July 1 cash has already helped to buoy municipal prices and boosted demand for recent bond sales, said Peter J. Allegrini, a portfolio manager for Fidelity Investments.
"During the last two weeks, deals have been orderly and methodic," Allegrini said. "That tells me there's a lot of demand for munis." Meanwhile, tax-exempt supply, which has been heavy throughout the year, is not expected to keep up with the strong demand prompted by July 1 cash, some analysts said.
As of June 11, 1993 volume totaled a record $125.08 billion, up 26.6% from $98.79 billion for the same period one year ago.
The supply reduction should help to keep municipal prices strong, but could cause a scramble for bonds later in July, several analysts forecast.
Most bond analysts and portfolio managers are recommending that individual investors choose intermediate maturity tax-exempts as the place to reinvest July 1 cash.
Cooner suggests that retail investors consider high quality bonds with maturities ranging from seven to 10 years. Currently, quality spreads are narrow. "I'm not opposed to considering lower quality bonds provided I get paid for the risk involved." he said.
But without the additional yield, lower rated bonds are not very enticing, he said.
Cooner noted that several upcoming general obligation bond sales from issuers such as Atlanta, Ga., and Oregon should provide attractive investment opportunities.
Lauren J. Eastwood, director of research at Gabriele, Hueglin & Cashman, a regional municipal firm, is also rccommending intermediate maturity bonds for reinvestment cash.
Eastwood suggests investors consider munictpals with maturities ranging from eight to 10 years. For example, a triple-A rated bond yielding 4.70% and maturing in eight years carries a yield only 90 basts points lower than triple-A rated municipals maturing in 30 years.
Lord Abbett's Dow is one of only a handful of fund managers touting long-term bonds.
"Ten- to 15-year bonds are not that much less volatile than longer term bonds," Dow said.
Sitting on the sidelines waiting for interest rates to climb higher could be "Iethal" for retail investors, cautioned C. Frazier Evans. senior economist at Colonial Investment Services in Boston.
"You don't know when the pre-refundings are going to trail off" and supply will lessen, he said.
"My particular counsel to investors is ~act now'. Don't sit on your hands. This may be the last opportunity to nail some yields which are relatively high," Evans said.