Taxable Municipals – Myths and Misperceptions


Anthony Tanner, CFA®

Taxable Municipal Bonds grabbed the attention of not only municipal bond market participants in 2020, but also of investors and financial professionals globally across the asset class landscape.

Nationally, new issue volume growth was confined to the burgeoning taxable municipal bond sector, where issuance doubled from $72.2 billion in 2019 to $145.2 billion in 2020. By comparison, tax-exempt issuance in the municipal bond market declined slightly from $354 billion to $328 billion.

The eye-popping issuance figures for taxable municipal securities made headlines throughout the year. The $145 billion of new taxable municipal bonds were issued as fully Federally taxable, but in most cases, retained the applicable state tax exemption. This accounted for almost one third of all municipal bonds issued and ultimately accounted for the entire increase in total issuance in 2020. The prominent rise of this mechanism in the municipal market occurred as a consequence of the component of the 2017 Tax Cuts and Jobs Act which eliminated tax-exempt advance refunding of tax-exempt issues.

Questioning The Tax Exemption – Again

With taxable municipals accounting for such a prominent slice of state and local government borrowing there has been growing speculation in the financial press, and among market participants, about what this means for traditional tax-exempt financing. Common viewpoints gaining traction have called into question the need for traditional tax-exemption in municipal finance and even suggested the success of taxable issuance in 2020 proves municipal bonds can exist without the tax-exemption.

This speculation has been fueled by a number of misperceptions about the municipal bond market and the nature of public finance. The explosion in taxable issuance ultimately resulted from the confluence of two watershed developments:

• The arbitrary prohibition of the advance refunding mechanism that had been a staple of municipal finance for 100 years.

• Generational lows in benchmark U.S. Treasury yields off of which the yields of other taxable securities are “spread” by a variety of taxable investors.

What these developments ultimately point to is the simple continuation of the old fashioned resourcefulness of the nation’s municipal finance officials: optimizing the borrowing costs of their taxpayers and constituents, rather than a long-run steady state “transformation” of the municipal bond market.

Tax Cuts and Jobs Act – Where It All Began

The 2017 Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017. It was hailed as significant tax reform, primarily for its reduction in marginal individual income tax rates, although its “significance” seems muted compared to the 1986 Reagan-style tax reform that dropped top rates from 50% to 28%. Of greater impact to the municipal market was its provision that prohibited the advance refunding of tax-exempt securities with proceeds from tax-exempt issues.
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Updates and Perspectives: The Arizona Economic and Pandemic Recovery


Arizona recently reported an unemployment rate of 6.7% in September, adding 30,200 more jobs. While it was an increase from the 5.9% rate reported in August, the uptick was fueled by an increase of 150,000 in job seekers entering the labor pool. This jump was attributed to the quickly recovering state economy that offered motivation and hope for those who had lost jobs when the state economy was “furloughed” in April.

The reopening of the economy following the end of Governor Ducey’s shelter at home mandate has helped drive the unemployment rate down almost 40% from a 10.7% rate in July. Arizona now boasts an unemployment rate well below the overall US rate reported in September of 7.9%. Impressively, only two states larger than Arizona (Virginia and Georgia) reported a lower unemployment rate (6.2% and 6.4%, respectively) in September.

Payrolls Protected are the Key

Arizona’s economic recovery from the Coronavirus pandemic accelerated dramatically in the past quarter.

Most encouraging has been the resilience of overall employment levels in the state. The employment base is the lifeblood of the State economy and can be a significant proxy for the health of the state and local government finances. Maintaining employment levels translates to jobs kept, household incomes maintained, income and sales taxes paid, and tax bases sustained.

From August 2019 – August 2020 employment in the state declined only -3.2%, ranking 4th lowest in the nation and the best among any state of its size or smaller. This deterioration in the employment base was less than half the U.S. average of -7.0% for this period.

This is especially impressive when considered within the context of the largest states. Arizona is currently the 14th most populous state. Among the thirteen larger states by population, only three (also “sunbelt states”) retained a higher share of jobs than the national average:


Fiscal Stimulus: Everyone Benefits When Small Business Wins

Arizona is seeing the massive injection of fiscal stimulus weave its way into the economy. The Payroll Protection Program (PPP) Loans have been one of the main contributors to economic stability to towns and local governments in Arizona. According to SBA figures, over $8.6 billion of PPP loans have been made to 81,000 recipients in Arizona, potentially saving over 750,000 jobs statewide. This encompasses a broad swath of industries, businesses, and organizations throughout the State.

Almost 70,000 such loans were for less than $150,000. This was a critical component of Arizona’s employment resilience as small businesses are an especially prominent engine of the Arizona economy. The massive fiscal response of the Federal government to the Coronavirus Pandemic, and its implementation at the state and local level, helped employment at small businesses rebound dramatically.

When widespread lockdowns of state economies took place last April, employment at small businesses with 49 or fewer employees experienced a decline that was three times that of larger companies with over 500 employees. But by the end of September, after the sizeable fiscal relief was targeted to small business, employment of those small employers had shown the largest recovery:

Read more “Updates and Perspectives: The Arizona Economic and Pandemic Recovery”


A Perspective on Recent Muni Market Volatility


The municipal bond market experienced one of its most disruptive and volatile market periods in recent memory during the week of March 9, 2020. After steadily moving higher for past 15 months as the Federal Reserve initiated a new easing policy, municipal bond prices declined sharply last week in response to increased economic disruption brought about by the rapidly evolving coronavirus pandemic.

The volatility in municipal bond prices and municipal bond fund mutual funds last week was indeed both abrupt in its speed and significant in magnitude. However, such municipal bond market behavior has in fact occurred on several occasions in the past thirty years. In the context of these prior periods, the price and trading activity in the municipal market last week reflected the very “normal” manner in which the municipal bond market has behaved in “abnormal times”.

Also in the context of the overall municipal bond market, the intermediate maturity and investment grade mandate, in which all Aquila municipal bond fund portfolios are structured, helped deliver less fluctuation than that of long term bonds last week.

Unusual – But Not Unprecedented

On March 12, 2020, the Net Asset Value of the Aquila Tax-Free Trust of Arizona’s (ATFTA) Class A Share declined 2%. This compared to long term bond funds who suffered Net Asset Value (NAV) declines of as much as 3%, and large actively traded national municipal bond Exchange Traded Funds (ETFs) which dropped 5% that day. This greater degree of downside stability reflected the benefits of both the intermediate mandate and very broadly diversified portfolios that are the foundations of our locally managed municipal bond funds. You may find the Fund’s latest performance here.

This magnitude of one-day price fluctuation was not unprecedented though. On Tuesday April 4, 1994 intermediate and long term municipal bond NAVs also declined 3%-4%. I had the opportunity to experience this market turmoil firsthand while co-managing two investment grade, single-state bond funds with short term and long term maturity mandates at the time. On that day, coming off an extended Easter holiday weekend, the Federal Reserve made a surprise increase in the discount rate as part of a significant monetary tightening they had started at the beginning of 1994.

By the end of that Tuesday, the 10-year US Treasury bond yield increased 39 basis points from 6.75% to 7.14%, and the 30-year US Treasury bond yield spike 32 basis points, from 7.10% – 7.42%. The Bloomberg Barclays AAA 10-year Maturity Index yield rose a more modest 25 basis points. This sudden spike in yields along with very thin trading activity in a volatile market translated into the sharp NAV declines of that day. The Class A Share of ATFTA declined 19 cents that day, fairly commensurate with the unusually large one day declines experienced last week. One difference in these two periods is that last week’s volatility was induced by significant economic stress, rather than Federal Reserve policy and the long term direction of benchmark interest rates. Last week also shared common themes with the height of municipal market volatility that occurred near the end of 2008 during the great recession.

Over a three-week period from the week of November 18th to December 15th in 2008, the NAV of ATFTA declined 4.4% as the shadow of corporate bankruptcies and bailouts weighed on the municipal bond market. Long-term funds suffered even sharper declines of as much 7%. Again, we believe an intermediate maturity focus and portfolio breadth helped to mitigate a good degree of the downside risk of this period.

What was mostly unusual about this period was that US Treasury bond yields moved significantly lower throughout this period as the Federal Reserve aggressively moved to inject liquidity into the market. For example, 10-year US Treasury bond yields declined from 3.77% to 2.51% even as comparable AAA municipal bond yields increased 32 basis points to 4.44%. The polar opposite behavior of these markets was even more pronounced in the long end of the yield curve. Benchmark 30-year US Treasury yield declined from 4.23% to 2.95%, while the Bloomberg Barclays AAA 30-year Maturity Index yield increased 63 basis points to 5.77%.

The Return of Genuine Relative Value

This window of volatility behavior near the end of 2008 was similar to what the muni market experienced last week, as the increase in municipal bond yields were double those of benchmark US Treasury bonds. This resulted in a significant underperformance of the municipal bond market that has left municipal bond yields at compelling valuations which are reminiscent of those in December 2008.

As of this writing, Bloomberg Barclays Fair Value 10-year and 30-year AAA municipal bond index yields equal 210% and 173% of comparable maturity US Treasury bonds. In December 2008, those same yield ratios were 177% and 196% respectively. For real market perspective, look at the yields offered in a $709 million Salt River Power Authority Bond issue that came to market the week of January 12, 2009:

The Search for Value is Not a Predictive Exercise

It is important to put municipal bond price volatility, elevated municipal bond yields, and tax exempt/taxable yield ratios in their proper perspective. In prior thought leadership papers, we have pointed out the importance of components of return in fixed income investing. In particular, it is important to keep in mind that the lion’s share of long run total return in municipal bond investing is derived from the income. The corollary is that over the long run, price changes contribute a small amount towards, and only detract a small amount from, total return.

Total Return Breakdown of the

Bloomberg Barclays Municipal Bond Index Since Inception 

Over the very short run (like a very volatile week in March of 2020, or day in April 1994) prices changes can overwhelm income. This is even more true today than in the much higher interest rate landscape of the 1990s and 2000s. Which makes evaluating and staying committed to a well thought out asset allocation plan vital. Doing so enables investors and advisors alike to focus on whether the fixed income tool in an asset allocation plan can provide an attractive level of income after taxes that protects purchasing power, while mitigating a large degree of volatility across the fixed income and equity universe.

Given current stock market volatility and the wild swings in taxable bond prices of the past week, conservative and consistently managed municipal bond portfolios appear to now offer enhanced long run value. Such value is not a guarantee against further fluctuation or price declines, but rather an indicator of the degree to which municipal bonds may be able to assist in the achievement of overall asset allocation objectives.

Over the next several weeks, we look forward to sharing further insights into a few of the market dynamics that are unique to the municipal bond asset class, how they shape municipal bond price fluctuations, and the opportunities they present that a local management perspective can capitalize on for shareholders. Read more “A Perspective on Recent Muni Market Volatility”


The Arizona Municipal Bond Monsoon


Arizona municipal bonds were plentiful in the new issue market during 2019. In fact, it turned out to be the busiest year for new municipal bond issuance in the state for the entire decade. A total of $7.9 billion of new municipal bonds from Arizona’s state and local governments came to market, eclipsing the previous high of $7.5 billion that came to market in 2016. That year, issuers accelerated their borrowing in advance of the 2016 election and potential tax law changes that were expected to limit municipal borrowing.

Revenue bonds dominated 2019 issuance, comprising 83% of the total in Arizona, which is not surprising. Unlike larger states like Illinois and Texas, Arizona does not issue tax-supported general obligation debt. In fact, only about 10% of the approximately $44 billion in outstanding munis in Arizona are state-related obligations.

New municipal bond issues were dominated by the Education, Healthcare, and Transportation sectors, whose capital projects and borrowing needs are most associated with a rapidly growing population. These three sectors accounted for 63% of the total issuance and almost 70% of the new deals brought to market.

We have highlighted the population growth in Arizona, led by Maricopa County, in recent Aquila Tax-Free Trust of Arizona investment commentaries. Well thought out new construction, expansion, and maintenance capital projects are vital to both enhancing the basic service needs and necessary infrastructure facilities that maintain the quality of life for Arizona residents. Read more “The Arizona Municipal Bond Monsoon”


Cheaper by the Portfolio – The Mutual Fund Value Proposition


The art and practice of picking individual municipal bonds can be a lot like picking apples. Finding great values or a real gem is primarily a function of market conditions and variety. If one has a discerning taste in apples they are more likely to encounter a wider variety of in season, locally grown apples at a farmers market rather than at Costco. With municipals, it’s always easier to obtain value when there is wide variety of both the types of bonds available and sellers willing to trade.

In today’s municipal bond market, demand is strong (not much variety in sellers) and yields are compressed across the yield curve (not much variation among yields), making it more difficult to find a great individual bond value. Combining this with the shift in Fed policy that has moved from tightening to easing in a matter of months, interest rates have been driven lower with a magnitude and speed that has resulted in the market yields of some individual bonds falling much further than the distribution yield of a diversified mutual fund portfolio.

In a market like we are experiencing today, the most attractive municipal bond values may actually be found in established, well diversified municipal bond mutual fund portfolios. This applies to both establishing new exposure to municipal bonds in an asset allocation, and to reinvesting maturity proceeds or making additions to an existing fixed income portfolio.

In comparing the change in intermediate market yields of some individual bonds with the yields of Aquila Tax-Free Trust of Arizona (AZTYX) for example, there is now a substantially larger yield advantage in the Fund. After peaking the first week of November 2018, market yields of individual bonds across the intermediate yield curve have fallen dramatically.


while the SEC 30-Day yield of AZTYX has held up better (please read the Fund prospectus here):


This can be attributed to a couple factors. First, active portfolio management may enable a fund manager to better sustain the portfolio income and dividend of a mutual fund by capitalizing on the opportunities that fluctuating interest rates often present (sort of like having a personal shopper at the muni bond “farmers market”). Second, the market yield and price change of an individual bond is more sensitive to a change in market yields than the yield and price change for a diversified portfolio of bonds.

That is because the average maturity and duration of a portfolio of bonds is not the same as the actual maturity and duration of any one specific bond.
Read more “Cheaper by the Portfolio – The Mutual Fund Value Proposition”


Arizona’s Dynamic Healthcare Sector


Anthony Tanner, CFA®, is the Lead Portfolio Manager of Aquila Tax-Free Trust of Arizona

Here in Arizona, the healthcare sector is a vital component of the economy and a key contributor to the state’s growth. Demographic trends, such as the aging of the population and longer life expectancies, together with advancements in treatment and technology, have made healthcare a significant growth sector in Arizona. Beyond hospital and clinical care providers, Arizona’s dynamic healthcare sector encompasses institutions such as:

Barrow Neurological Institute, a world-renowned neurology and neurosurgery care center.
TGen, or the Translational Genomics Research Institute, an Arizona-based, nonprofit medical research institute that conducts groundbreaking research on the genetic components of complex diseases, including cancer, neurological disorders, and infectious disease.
The Phoenix Biomedical Campus, a 30-acre urban medical and bioscience campus in downtown Phoenix. This collaboration among University of Arizona, Arizona State University, and Northern Arizona University includes biomedical-related research, academic, and clinical facilities. It is home to the highest concentration of research scientists and complementary research professionals in the region.
Bioscience funding leaders including the Flinn Foundation.

The expansion of the Arizona healthcare sector is also necessary in serving a population that continues to grow faster than the national average and captures a significant share of the shifting national population. The state ranked 4th in both population growth at 1.7% and absolute population increase at 122,000 in 2018. Arizona continues to attract a significant portion of those relocating, ranking 3rd for net migration. In 2019 the state is expected to see an increase in population above 100,000 for the third consecutive year.

Healthcare is an important engine of growth and employment stability in Arizona. Even during the Great Recession, employment in the healthcare sector expanded at a time when Arizona shed nearly 300,000 jobs and total employment contracted 11% (Nevada was the only state with a steeper decline in the period).


An advanced, diverse, and thriving healthcare industry is critical to Arizona, serving both as a magnet for attracting new residents, and providing world-class medical care to a state population that surpassed 7 million last year. Aquila Tax-Free Trust of Arizona (“ATFTA”) participates in this important economic driver through investments that support important healthcare projects. Last fall, the Fund added new holdings in this sector through two new issues sold to expand existing facilities, at a time when other parts of the country are seeing hospital systems shutter facilities as their populations stagnate or even decline.

In October, we made a new investment in the Maricopa Integrated Hospital System through a purchase of AAA-rated general obligation bonds sold through the Maricopa Special Healthcare District. In addition to providing funds for system-wide improvements to its existing county-wide facilities, $100 million of this $422 million issue is going toward the building of an extension of the Creighton University Medical School in central Phoenix. The four-year medical school is slated to open in August 2021 with 85 students; the facility will also be part of a health sciences campus with nursing and physical therapy programs. It will be a branch of the Omaha-based school and not a separately accredited medical school.
Read more “Arizona’s Dynamic Healthcare Sector”