It seems like everything is cheaper in Texas these days as the state lures residents and companies with a lower cost of living. Even municipal debt investors are now getting a bargain after a bond boom overwhelmed demand.
(Bloomberg) — It seems like everything is cheaper in Texas these days as the state lures residents and companies with a lower cost of living. Even municipal debt investors are now getting a bargain after a bond boom overwhelmed demand.
Texas governments and school districts are in the midst of a borrowing spree as the population swells. That caused bond yields to climb, giving investors a chance to buy pristine credits that are yielding 40 or even 50 basis points higher than the AAA benchmark.
Those rates have climbed so high that it makes sense for investors in a bevy of other states to buy Texas bonds. Meanwhile, the credits offer a safe haven: The state is one of a dozen that’s rated AAA, higher than the federal government. Texas is considered the eighth-largest economy in the world.
Ten-year Texas school-district bonds enhanced by the state’s guarantee program are yielding roughly 41 basis points over the AAA benchmark, more than double the average spread over the last five years and near the widest on record, according to data compiled by Bloomberg.
A key factor for the bonds’ affordability is simply supply and demand. Texas municipal-bond issuance has jumped a whopping 35%, according to data compiled by Bloomberg. And unlike high-tax states like California, Texas lacks an inherent built-in investor base eager for a tax-exemption since it doesn’t levy a state income tax.
That means the Texas debt often trades at cheaper levels than New York and California, which trade at more expensive levels in what can be considered a “clientele effect,” according to Doug Longo, co-head of product specialists at Dimensional Fund Advisors in Austin.
Hefty Texas Yields
Whether it’s a good idea to buy Texas bonds or not can depend on where investors are located, their tax bracket and the yields on the bonds.
Western Asset Management’s Samuel Weitzman estimates the benefit is most pronounced for investors living in states with effective income tax rates below 10%. “That is likely where we would exploit this dynamic,” he said.
For example, Norwalk, Connecticut, sold AAA rated debt in August that yielded a paltry 2.73% for bonds due in 10 years. A wealthy resident — subject to the highest tax rates and filing jointly — would have to buy an out-of-state bond with a yield of at least 2.94% to make that trade worth it, based on an online tool offered by Eaton Vance Management.
The investor could find that — and then some — in the Texas muni market, without having to sacrifice a pristine credit rating. Hutto Independent School District, for example, sold debt that offered a 3.18% yield in 2033. And Princeton Independent School District sold bonds yielding a 3.26%. Both deals were rated AAA thanks to the state’s program.
Supply Surge
School districts have driven much of the supply surge in Texas, and their bonds have been especially cheap, investors say. The districts have been flocking to take advantage of a program run by the state’s more than $50 billion sovereign wealth fund — the Texas Permanent School Fund — that guarantees the debt, giving them a AAA rating and reducing borrowing costs.
The deluge has caused the bonds to cheapen, said Adam Weigold, head of municipal strategies at Manulife Investment Management. Some AAA rated school-district deals issued with the guarantee can feature credit spreads of more than 50 basis points, he said. “Historically that would be quite a bit tighter.”
And issuance shows no signs of slowing down. In Williamson County, near Austin, officials approved putting a $884 million bond package on the ballot in November for infrastructure projects. And voters in Harris County, which encompasses most of Houston, will consider a $2.5 billion debt measure to expand hospitals for the poor and create neighborhood health clinics.
“We believe the currently ‘cheap’ Texas paper is just a factor of supply and demand,” said Leslie Martin, a Richardson, Texas-based portfolio manager for Cavanal Hill, in an email. She said the surge of AAA rated school bonds has been a great buying opportunity. “High-level, we aren’t seeing credit concerns in Texas — the opposite, in fact.”
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