Governments Refinance Record Amount of Munis

A record volume of tax-free municipal bonds was redeemed Wednesday, before their scheduled maturity date, as issuers refinanced older, higher-paying bonds with new, less-expensive securities.

Traders said about $8 billion worth of the bonds, which are debt sold by states and cities to finance everything from schools to sewers, were “called.”

That meant that many holders who had been receiving tax-free yields of about 12% on the munis will have to settle for today’s yields of about 6% on long-term high-grade bonds.

“This represents the biggest ‘call’ to date,” said Peter Coffin, municipal bond fund manager with Massachusetts Financial Services Co.

What many municipal bond issuers are doing can be likened to what homeowners have been doing as interest rates have fallen--refinancing.

In doing so, issuers are exercising preset call provisions--typically 10 years after the bonds are created. Prior to that period, they cannot be refunded.

Most bonds have two coupon interest payment dates a year, usually Jan. 1 and July 1. For the many state and local governments issuing bonds in 1982, when interest rates were at their peak, July 1 was their first opportunity to refinance.

The number of municipal bond issues this year has soared to near-record levels as state and local governments have rushed to exploit the relatively low cost of borrowing, according to the Public Securities Assn.

Since January, $95 billion in long-term bonds has been issued, against $75 billion through June of last year. Issues in the year are expected to exceed $210 billion, against last year’s $170 billion and close to 1985’s record $222 billion, the association said.

The muni market took off in the early 1980s even though interest rates were high, Coffin said. Major issuers included power plants and the New York Municipal Assistance Corp., an agency that oversees New York City’s finances.

Back then, banks were large investors, alongside property and casualty insurers and private individuals. But in 1986, Congress overhauled the tax code, removing most tax incentives for banks to invest in municipal bonds.

The same reform, however, made it more attractive for individual investors to buy munis. Paperwork was increased on other tax shelters, and the amount of loss an individual could deduct from taxes was limited.

The tax advantages of muni bonds are a key attraction. Bondholders don’t have to pay federal income taxes on them, and in some cases they are exempt from state and local taxes.

Investors can buy munis directly or through brokers. They can also buy mutual funds that invest in munis and unit investment trusts.

Unlike a mutual fund, a unit investment trust has a fixed portfolio of bonds and a maturity date. Investors receive a monthly income, and when the bonds are redeemed or mature, trust owners get their money back.

Despite today’s lower yields, most investors are still opting to reinvest in munis, said Mark Tenenhaus, first vice president at Dean Witter Reynolds Inc.

“Some investors, facing much lower yields, are feeling a bit of a culture shock,” Tenenhaus said. “But the alternative investments aren’t great.”