Underwriting spreads inched up in first half

Underwriting spreads for all bonds inched up in the first half of 2023 bucking a nearly 15-year downward trend, according to Refinitiv data.

After hitting what was a 20-year low last year, gross underwriting spreads for all bonds rose modestly to $3.70 in the first six months of 2023, up from $3.54 in the first half of 2022, according to the data as of June 30.

It was the first time in 14 years that spreads for all bonds rose and didn’t trend lower in the first six months of the year, the data indicated. Market sources said a combination of increased competition for a shrinking volume of bonds, and a changing market climate, could have caused the slight uptick.

Gross underwriting spread is the payment or underwriting discount an underwriter receives to market a deal. It is expressed as the dollar amount of underwriting discount per $1,000 of an issue.

While the 2023 mid-year spread is still among the all-time lowest on record over the last 20 years, municipal sources say the increase could be a temporary side effect of current market conditions and poised to return to recently seen trends.

“The wider spreads are likely correlated to very specific market conditions, yet we expect the overall trajectory of tighter spreads that have evolved over years to continue,” Jeff Lipton, managing director and head of municipal credit and market strategy and municipal capital markets at Oppenheimer & Co.

“Last year was a low supply year with more competition to get deals,” Lipton said, noting that it may have impacted spreads slightly higher. “We may very well see more normalized spread activity during the second half of this year.”

Despite his prediction, Lipton is not ruling out a possibility that overall spreads could continue the latest trend.

“Should intermittent market conditions come about, a wider spread profile could prove to be transitory,” Lipton said. For example, a large deal, or a number of large deals, could create wider spreads as more spread is often needed to move paper and hedge risk, particularly in a rising interest rate environment that the market has seen in recent years, Lipton noted.

Looking back, spreads fell below $4 for all bonds back in the first half of 2022, the first time in nearly 20 years, compared with 2003 when spreads were at $5.20, according to historical data from Refinitiv.

The gross underwriting spread only piqued higher than $5.20 once back in 2009 when it hit a one-year blip of $6.21, according to the data.

Current market and state budgetary conditions could be the reason behind the slight bump in spreads so far in the first half of 2023, according to John R. Mousseau, president and chief executive officer and director of fixed income at Cumberland Advisors.

“I think that some of the increase in spread is that — though issuance is down year over year — looking forward the market sees some of the surpluses that were so prevalent in state and local governments starting to melt away,” Mousseau explained, pointing to the state of California’s budget as an example.

“I would fully expect that state and local governments will need more financing going forward, even if at somewhat lower rates as inflation comes down,” he said. “So, the overall risk profile probably increases as you go further into the future.”

Anecdotal signs, according to Mousseau, include increased delinquency on car loans, increases in installment debt, higher mortgage rates impinging housing, and the vast overhand of commercial real estate with high vacancies in many big cities.  

“So, spreads could increase because the risk profile is increasing,” Mousseau said.

Others, like Dan Solender, partner and director of tax-free fixed income at Lord Abbett, believe that the imbalance of negotiated compared to competitive supply and refunding compared to new issue volume are factors in the spread widening in the first half, albeit small.

Spreads on negotiated bonds rose to $3.78 from $3.53 previously, while spreads on competitive deals fell to $2.61 from a previous $3.79, the data showed.

Gross spreads for refunding bonds was $3.36 in the first six months of 2023, which is noticeably lower than the spread for all bonds for the first half of the year.

Year over year, however, the spreads for refunding bonds did increase compared to the first half of 2022 when they were at $2.90, according to the Refinitiv data.

“Since the proportion of deals that are refunding are lower this year, that would make it seem that the higher proportion of new-money could have an impact on pushing spreads [on all bonds] higher,” he said.

Solender noted the refunding sector has less spread than the total for all bonds, which isn’t surprising.

Refunding spreads have been steadily declining since 2019 when they were at $4.23, according to Refinitiv.

New-money spreads in the first half of the year rose to $3.88 from $3.70 in the prior year’s first half, the data showed.

Solender said more time is needed to gain better analysis.

“The movement in spreads likely has more to do with the composition of new supply than an industry move to higher spreads, but we need a longer time period to know this for certain,” he said.

Other sectors, such as development, showed a noticeable drop in spreads, falling significantly, to $4.72 from $9.72 in the first half year over year as a result of decreased market demand for and overall lack of financing by municipalities in development projects, sources said.