Institutional Investors May Benefit From More Complex High Yield Muni Market

Rising issuance of munis available only to qualified institutional buyers (QIBs) may offer higher yields to investors who can access them.

The high yield municipal bond market has grown more sophisticated. Over the past five years, issuance of unrated securities and bonds that can be purchased only by qualified institutional buyers (QIBs) has risen sharply (see chart) – and in the process created distinct opportunities for qualified investors.

‘QIB-only’ often means higher yield potential

A heightened focus on underwriting disclosure and increasingly complex credit structures have caused underwriters to be more conservative about which deals can be offered directly to retail investors. A QIB distinction (as defined in SEC Rule 144A under the Securities Act of 1933) essentially limits participation to large institutional buyers, and the restricted investor base generally has led to higher yields for investors who can access these deals in either the primary or secondary markets.

Notably, the average spread between yields on QIB and non-QIB bonds issued this year stands at 90 basis points (bps) for the Bloomberg Barclays High Yield Municipal Bond Index (through 30 September 2019).

Despite extracting higher yields from issuers, QIB-only bonds continue to rise as a percentage of the high yield muni index, to 22% currently – and 68% of these bonds were issued since 2017. Unrated bonds are also on the rise and currently represent 54% of the high yield muni index, and more than half were issued since 2017.

Market access paired with robust credit analysis is critical

The credits in the pool of unrated and QIB-only bonds are diverse, including hospitals, charter schools, recycling plants, refiners, real estate developments, casinos, and retirement homes. We believe appropriately evaluating the risks associated with many of these credits, particularly their legal structures and revenue streams, requires broad and deep global credit analysis capabilities that go beyond the expertise needed to analyze state and local municipal debt.

With issuance of unrated and QIB-designated bonds likely to keep climbing, investors who are able to both access these bonds and appropriately evaluate their credit risks will be positioned to tap their potential benefits.

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