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What is the difference between the new issue and the secondary municipal bond market?

Quick Take on Fixed Income
April 2015

Q: What is the difference between the new issue and the secondary municipal bond market?

A: Essentially, there is little difference between the two markets. Their structure is identical in terms of credit quality, revenue source, price and yield. The new issue realm is the initial offering of a security, similar to an initial public offering in the equity market. However, the volatility that is sometimes associated with an equity IPO does not exist in the high-grade new issue municipal market. The new issue market is simply the means by which a municipality raises cash by issuing debt. The only material discrepancy between the two markets is that newly issued municipal bonds typically have an extended settlement date of 1-2 weeks, as opposed to T+3 (investing shorthand for trade date plus three days).

Why municipal bonds are purchased in the new issue market
The bonds used in our clients’ portfolios adhere to a strict list of buying parameters. Only high-credit-quality bonds are purchased, with yield becoming the determining factor in many cases. Municipal offerings in the new issue market often have a slightly higher yield, for two main reasons. One, municipal underwriters are taking on the risk of potentially owning some of the securities (as with an equity IPO), so those traders want to ensure the bonds will be attractively priced. Two, newly issued bonds inherently increase supply in the overall marketplace, causing the economics of supply and demand to affect municipal bond prices. All things being equal, a significant increase in municipal supply will decrease overall bond prices, leading to higher yields.

Why municipal bonds are purchased in the secondary market
The main reason to not purchase more bonds in the new issue market comes back to yield. Although municipal bonds typically do have a slightly higher yield in the new issue market, this is usually relative to a specific state. Generally, our clients can obtain a better overall yield outside of their state of residence. Some states either have a naturally higher supply of municipal bonds or a lower in-state demand for municipal bonds (particularly those with no state income tax, such as Florida, Texas or Washington). Once an appropriate credit quality is determined, a judgment is made on how to achieve the best combination of yield and credit quality, regardless of whether the bond is in the new issue or secondary market.

Bottom line
The new issue municipal market is simply another source to purchase bonds for our clients. There is essentially no difference between a muni bond purchased in the new issue market and one purchased in the secondary market, aside from an extended settlement date.


Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.

 

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