State and local governments barred from a key refinancing tactic are turning more than ever to a funding tool that helps them avoid the risk of rising interest rates.
Sales of municipal bonds that won’t be delivered to investors until months after they price have reached about $10.5 billion in 2021, up 174% from the same period a year ago and on pace for a record, according to data compiled by Bloomberg. California issued the largest ever so-called delayed-delivery bond four months ago, while deals by issuers from across the country are set to price in the weeks ahead.
The structure allows state and local governments to lock in interest rates in anticipation of refinancing higher costing debt that’s not yet eligible to be called back. It’s an attractive tool for governments that believe rates are going to rise, said Vikram Rai, head of municipal strategy for Citigroup Inc. The structure has grown in popularity since a clause included as part of former President Donald Trump’s 2017 tax cuts banned the sale of tax-exempt bonds to refinance debt ahead of the call date.
“It’s a rate call,” Rai said in an interview. “Rates are low and I find it difficult to believe that they will go lower.”
California sold nearly $1.1 billion in April to be delivered next month, and the state plans to sell $372 million of the same structure in October. The Phoenix Children’s Hospital is selling $150.4 million through the Arizona Industrial Development Authority that will be delivered in November. And Connecticut’s Health and Educational Facilities Authority sold $206 million Wednesday that will be delivered no earlier than April.
The rising volume of forward sales comes as demand outpaces the supply of new bonds in the $4 trillion muni market, leaving yield-hungry investors willing to take on more risk to boost returns.
Rising inflation, the potential for Treasury yields to climb higher and the possibility the Federal Reserve starts tightening monetary policy could all shift future pricing for state and local governments. Ten-year top rated municipal benchmark bonds currently yield about 0.9%, according to Bloomberg BVAL pricing.
“What’s in it for us is we get the advantage of low rates,” Tim Schaefer, the deputy treasurer of public finance for the state of California, said in an interview. The state began issuing large chunks of bonds for forward delivery last October, and while it doesn’t make interest-rate predictions, it wants to benefit from the low-yield environment, he said. “All of our risk of rate fluctuation beyond the date we sign the contract is thus eliminated. We have certainty.”