Tax-Exempt Market Providing a Shield for Investors of Corporate-Backed Debt

Corporate-backed bonds in the tax-exempt municipal bond market have retained their value in recent months compared to similar corporate-backed bonds in the taxable bond market. Under federal tax statutes, bonds backed by private companies may be issued on a tax-exempt basis for specified purposes, such as pollution control facilities. As a result, some corporations back debt in both the muni and taxable bond markets.

In 2015, the prices of the tax-exempt debt of those corporations have been more stable than the taxable debt. For example, tax-exempt bonds issued in local governments in Louisiana for facilities owned by Marathon Oil Corporation (Baa1/BBB/BBB+) have fallen by about two cents in the third quarter to about 102 cents on the dollar. In contrast, prices of Marathon’s taxable debt have fallen from 96 cents on the dollar to 88.5 cents during the third quarter. While SNWAM does not hold any Marathon Oil debt, we hold both tax-exempt and taxable debt issued for Waste Management Inc. (Baa2/A-/BBB). While the price of Waste Management’s tax-exempt and taxable debt have remained stable, the tax-free bonds total return during Q3 was about 50bps higher than the taxable bonds in the 3 year part of the yield curve.

The outperformance of corporate-backed tax-exempt debt relative to corporate-backed taxable debt has been fueled by technical factors. The supply of corporate backed bonds in the Q3 exceeded $315 billion, a 4.5% increase over Q3 of 2014. Conversely, the issuance of corporate-backed munis for the entire year is still shy of $300 million. On the demand side, taxable bond funds have been bleeding assets in 2015. During the week ending October 7, taxable bond funds had over $6.3 billion of outflows while muni bond funds had inflows of $558 million. In September, taxable bond funds had outflows that reached $16.4 billion while outflows of muni bond funds exceeded inflows by about $750 million.

Sources: Bloomberg, SIFMA, ICI