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Heavy Supply Pushes Tax-Exempt Yields Higher

September 21, 1985

NEW YORK (AP) _ The unrelenting flow of new municipal bond issues has begun pushing tax- exempt yields higher, making the securities more attractive for investors.

Analysts say they expect volume will remain high through the end of the year as issuers try to float tax-exempt bonds in advance of anticipated changes in the tax laws relating to such issues.

The high volume has also stemmed from efforts by some issuers to substitute lower-yielding bonds for costly, high-yielding securities that they sold several years ago when the general level of interest rates was higher.

But analysts say there are factors emerging that could help ease further upward pressure on municipal rates.

Tax-exempt yields had drifted in a narrow range since late July, but broke sharply higher two weeks ago and extended their upward drift this past week.

According to a 20-bond index of 20-year general obligation issues tracked by the trade newspaper Bond Buyer, yields rose to 9.35 percent in the latest week, up from 9.07 percent two weeks earlier.

It is the highest yield on the 20-bond index since it was 9.37 percent in early May.

″The continuing huge new-issue volume has apparently taken its toll,″ George Friedlander, who follows the municipal market for the investment firm Smith, Barney, Harris Upham & Co., wrote in a recent commentary on the market.

He noted that for each of the past 13 months, volume has exceeded the level in the same month of the previous year.

Volume for January through August, he said, amounted to $79.2 billion this year, up 59.2 percent from $49.7 billion in 1984.

Friedlander said it would appear that ″much of the additional volume was absorbed directly by retail investors,″ who over the past several years have displaced financial institutions and insurance companies as the major buyers of tax-exempt bonds.

″Not surprisingly, the expanded volume and increased reliance on direct retail buyers has required a significant increase in yields on municipals relative to other fixed income securities,″ he wrote.

While current tax-exempt yields match early May levels, yields on 30-year Treasury bonds have fallen nearly 80 basis points. A basis point is one- hundredth of a percentage point.

As a result, tax-exempt yields have become relatively more attractive by failing to follow more closely the downward drift in taxable yields.

Howard Sitzer, who follows municipal securities for the investment firm Thomson McKinnon Securities in New York, said highly rated, 20-year municipal bonds were yielding about 83.3 percent of what taxable Treasury securities were late last week. ″That means munis are a good value versus taxables,″ he said.

Through most of the 1970s, Sitzer said, tax-exempt yields were no more than 70 percent of taxable yields.

But a few new factors are coming into play that could help decide whether tax-free yields will continue to rise or follow the recent downward drift of taxable rates, Sitzer and Friedlander said.

Sitzer said that the earnings prospects for property and casualty companies has improved appreciably for the first time since the late 1970s and that they may once again be interested in the tax-exemption which municipal bonds offer.

He said that during the late 1970s, such companies bought 25 percent to 30 percent of new issues, but have been net sellers of tax-exempt bonds in the 1980s. Expanding demand for tax-exempt bonds would place downward pressure on rates.

Friedlander said many refunding issues - securities sold to replace older and often maturing debt - ″have already been rushed to market in anticipation of tax reform.″ That may affect the outlook for new tax-exempt volume.

And finally, he said the decline in volume that traditionally occurs at the start of the year ″could be even more dramatic next year than it was this year,″ particularly if Congress enacts legislation placing new limits on ther tax-exempt market.

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