Municipalities Face Short-Term Cash Crunch, Pushing Up Borrowing Costs - Barron's

The municipal bond market may be exempt from taxes, but it hasn’t been sheltered from a record-setting investor cash grab.

A muni-market selloff that started last week is snowballing, pushing up state and local authorities’ cost of borrowing over a one-week period. Investors pulled $12.2 billion from municipal bond funds over the week ended March 18, the most of any week on record, according to Lipper. The second-largest outflow was $4.5 billion.

Interest rates have spiked to 5.2% on floating-rate municipal securities called Variable Rate Demand Notes, or VRDNs, up from 1.3% last week. That short-term rate—the cost of borrowing for one week—was higher than municipalities’ longer-term rates. The 30-year benchmark municipal bond yield was 3% on Thursday afternoon.

It was also higher than one-week interest rates on lower-rated commercial paper, which rose to 3.6% on Wednesday, according to the Federal Reserve.

There is one important difference between short-term corporate and municipal debt markets: The Fed is only directly involved in one.

Earlier this week, it created a vehicle to buy short-term corporate debt called commercial paper. But the Fed isn’t purchasing short-term munis just yet. And while the central bank has created a facility that accepts muni bonds as collateral, it is only accepting them from a select group of 24 bond dealers.

That adds to the pressure municipalities already face from the coronavirus. On the revenue side, state and local governments face a potentially huge jump in unemployment and a steep drop in economic activity. At the same time, investors are withdrawing record amounts of cash from the market.

“We cannot state with enough emphasis how significant the selling pressure has been on many of the institutional funds,” wrote Tom Kozlik, head of municipal strategy and credit with Hilltop Securities, in a recent note.

Withdrawals have put pressure on the exchange-traded funds tracking that market as well. The biggest one, the iShares National Muni Bond ETF (MUB), has lost 14.5% since the selloff started March 9, and is now trading at a 5.8% discount to its net asset value.

The iShares Muni ETF looks more liquid than muni bonds, however. And that means the broader market probably has farther to fall. Earlier this week Bloomberg’s platform had a record 11,000 bonds (or bond trades) out for bid, an all-time record, according to CreditSights.

More bad news about fundamentals hit the market on Thursday, as the Metropolitan Transportation Authority disclosed a steep drop in ridership as people stay home to avoid spreading coronavirus. The MTA’s bonds maturing on March 1, 2022, have declined more than three points so far this month, and the authority has requested $4 billion from the federal government to help offset the decline in subway ridership caused by the coronavirus.

“This is not a good sign for transportation and transit credit quality and we see it generally weakening as a result of [coronavirus] containment measures,” Kozlik wrote in his note.

Write to Alexandra Scaggs at alexandra.scaggs@barrons.com

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