Debt Management

Twos are the New Fives

Page from October 2021 GFR

There’s a subtle but seismic shift happening in the municipal bond market. States and localities should be aware of it and its consequences. When issuers set coupons on their bonds they go through a “Goldilocks” exercise. A bond that sells at a high premium suggests the issuer could have raised the same amount of money but with less debt service. Extreme premiums are also unattractive to some investors because they don’t produce noticeable cash inflows until close to the bond’s maturity. By contrast, if the bond sells at a discount, the issuer might not raise all the money it needs.

Discount bonds also have unique tax implications—for example, the “de minimis” rule—that makes them unattractive for many issuers. For these reasons, an issuer’s goal is to sell the bonds at a slight premium. That suggests the coupons were, just like Goldilocks’ porridge, not too hot and not too cold. For more than a decade, five percent, known as “fives,” was the Goldilocks coupon rate.