March was a difficult month for Kansas issuers to navigate for myriad reasons, operational and public health challenges notwithstanding. The bond market saw unprecedented volatility from day to day. As investors fled to safety, yields went down. When investors fled to cash, the bond market locked up almost entirely. In this unpredictable time, very few public competitive sales in Kansas were awarded, and some that were had higher than expected interest rates.
Meanwhile, the Federal Reserve has pulled every lever in reach to provide liquidity in the credit market and soften the landing for the economic crash as a result of coronavirus social distancing measures. These market dynamics, and more, have sent the 10-year U.S. Treasury to historic lows, presenting an additional challenge for Kansas issuers.
You may ask, “Why does the U.S. Treasury impact the marketability of Kansas bonds?” Kansas Statutes (KSA 10-1009) sets maximum coupon rates for Kansas municipalities’ fixed-rate bonds. The ceiling is set not to exceed the daily yield for 10-year treasury bonds published by The Bond Buyer on the Monday preceding the day on which the bonds are sold, plus 3% if the bonds are tax-exempt, or plus 4% if the bonds are taxable. In practice, this means the 10-year U.S. Treasury rate on the Friday before governs the coupon restriction for the sale. The table below shows the last four weeks of 10-year yields and Kansas coupon restrictions:
Municipal bond investors frequently desire 4% and 5% coupons on their bonds. Not only does this provide higher annual cash flow to the investor, but bonds with higher coupons better retain their value in changing interest rate environments. But Kansas issuers, by statute, cannot market their bonds in a fashion that best positions them for success while the 10-year U.S. Treasury is at historic lows.
This is an added challenge Kansas issuers must face as they market general obligation bonds. Efforts are underway to change KSA 10-1009 in the legislature, but its swift passage is by no means assured. In the interim, issuers should work with their municipal advisor to navigate these choppy waters.
For more information on this topic, or to learn how Baker Tilly public sector specialists can help, contact our team.