Am I correct in assuming that general obligation bonds may be more difficult to sell in our current interest rate environment? I’m speaking more about newly issued bonds. Since G.O. bonds use competitive bid underwriting with firm commitment, wouldn’t investment banks be wary about taking on that responsibility (ie firm commitment) at a time when interest rates have been so low for so long, and it appears that rates will soon be going up? Most investors would probably want to wait until rates went up a bit, before purchasing them…
If the above is correct, then it would seem that best-efforts underwritings would be more common in our current interest rate environment.
Finally, what steps would a municipality take in order to make GO bonds more marketable now? Offer higher coupons?
To be honest with you, I’m not closely monitoring the municipal bond markets. However, I understand your sentiment. Rising interest rate environments create challenges for anyone attempting to sell bonds. Regardless, I still would assume most G.O. offerings are occurring under a competitive bid process. Best efforts offerings are contingent on investor demand, and municipalities generally do not want to “wait and see” if their bonds sell. If a city gains voter approval to build a new high school, they’re under an obligation to do so, typically regardless of investor demand for bonds.
This is where the municipal adviser plays an important role. They should be helping the municipality understand the changing interest rate environment and how it will impact the overall cost of a project. In plain terms, the adviser should be informing the municipality of the increased costs of a project, which likely will increase the amount of the bond issuance.
If there’s more risk for the underwriters, they’ll obviously submit less favorable bids. These institutions are smart with their money, and are unlikely to get stuck with unmarketable securities without being compensated accordingly.
To answer your last question - yes! In a rising interest rate environment, that’s what every borrower is facing. I try to simplify it and think about these changes in terms of personal situations. I’m currently in the market to buy a new house, and am well aware of how rising interest rates will push my monthly mortgage payments higher. While rising interest rates are a pain for virtually all parties in the economy, it’s often necessary to stave off inflation.