In this month’s issue, we discuss the following headlines: Interest rates are rising, although still favorable on a year-over-year basis. Volatility in U.S. Treasuries continue to make municipals attractive to investors. Refundings continue to come to market, despite increased levels of negative arbitrage. Large issues keeping coupons in the 5 – 5.25% range.

Interest Rates Are Rising; U.S. Treasuries Are More Volatile Than MunicipalsBoth taxable and tax-exempt interest rates increased throughout April, most significantly during the final week of the month. Taxable U.S. Treasuries (including the 10, 20 and 30 year) rose an average of 13 basis points (0.13%). The tax-exempt Municipal Market Data (“MMD”) scale rose an average of 11 basis points (0.11%). As shown in Exhibit 1 to the right, the majority of movement occurred in the mid- to long-end of the yield curve.

Exhibit 2 compares changes in select MMD and U.S. Treasuries points over the past 12 months. The 5-year MMD has remained fairly flat overall. The 10, 20 and 30 year MMD rates have increased since the beginning of the year, but are down on a year-over-year basis. U.S. Treasuries, however, have experienced much more significant movement. The 5 and 10 year U.S. Treasury rates have both declined since the beginning of the year. On a year-over-year basis, however, U.S. Treasury rates have plummeted – nearly doubling the decline versus the MMD.

This rate see-saw can primarily be attributed to an often mixed bag of economic numbers and the Fed’s statement signaling that any rate increase will occur no earlier than September. Baird Chief Investment Strategist Bruce Bittles noted, “while the Fed may be looking for an opportunity to raise rates (September now seems like the earliest they could move), we are not sure that the incoming economic data or the global macro backdrop will support such a move. With downward pressure on inflation being seen around the world, the argument for pre-emptive action from the Fed is weakened.”

As we are now into May, will we see rates decline – continuing the see-saw effect? While this may seem a fairly remote possibility (as of this publication date), with the exception of 2013, the average MMD has generally declined each year through April and May (see Exhibit 3).

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Exhibit 1. The tax-exempt yield curve increased by an average of 0.11% during the last week of April

4/27/20154/30/2015

Yiel

d (%

)

Monthly Municipal Market Update Robert W. Baird & Co. Public Finance May 2015

For each maturity from 2024 – 2045, MMD yields rose between 12 and 15 basis points (0.12 – 0.15%) – a substantial increase in only a few short days.

MMD TSY MMD TSY MMD TSY MMD TSY5 YR 10 YR 20 YR 30 YR

(80)

(60)

(40)

(20)

0

20

40

Exhibit 2. Yield curve change from 4/30/15 (in basis points)

1-Apr-15 2-Jan-15 30-Apr-14

Basis

Poi

nts

2010 2011 2012 2013 2014 (50)

(40)

(30)

(20)

(10)

-

10

20 Exhibit 3. April to May Average MMD Movement

(in basis points)

5 10 20 30

Basis

Poi

nts

Municipal Bonds Remain An Attractive InvestmentAs discussed earlier and as illustrated in Exhibits 4 and 5, volatile is the best way to describe long-term rates over the past 16 months. Both MMD and U.S. Treasury rates have experienced major swings, particularly at the long-end of the yield curve. The low to high range for select MMD points are quite significant:

10-year MMD: 1.72% low; 2.79% high – a 107 basis point swing 20-year MMD: 2.35% low; 3.89% high – a 154 basis point swing 30-year MMD: 2.50% low; 4.20% high – a 170 basis point swing

U.S. Treasuries experienced similar swings.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50 Exhibit 4. MMD rates (high and lows) (2014 - April 30, 2015)

Series3

MM

D Yi

eld

(%)

MMD and U.S. Treasury rates have increased in 2015, but still remain low compared to 2014 levels. U.S. Treasuries, however, won the “hardest hit” award, plummeting by up to 73 basis points (0.73%) versus April 2014 levels.

1 YR 2 YR 3 YR 5 YR 7 YR 10 YR 20 YR 30 YR -

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50 Exhibit 5. U.S. Treasury rates (high and lows)

(2014 - April 30, 2015)U.

S. Tr

easu

ry Y

ield

(%)

The percentage of municipals to U.S. Treasuries has remained above 85% for the 10, 20 and 30 year maturities, making municipals an attractive investment due to their tax-free status (see Exhibits 6 and 7). Additionally, with higher tax rates on investment income in effect as of last year, the 85% bar typically used as a “break-even” may need to be lower, which will keep municipals in demand by investors.

60%

80%

100%

120%

140%

160%

180%

200%

April 30th Ratio, 103%

10 YR AVG; 93%

Exhibit 6. 10 YR muni to U.S. Treasury ratio (2006 - April 30, 2015)

Jan-

14Ja

n-14

Feb-

14Fe

b-14

Mar

-14

Mar

-14

Apr-

14Ap

r-14

May

-14

May

-14

Jun-

14Ju

n-14

Jul-1

4Ju

l-14

Aug-

14Au

g-14

Sep-

14O

ct-1

4O

ct-1

4N

ov-1

4N

ov-1

4D

ec-1

4D

ec-1

4Ja

n-15

Jan-

15Fe

b-15

Feb-

15M

ar-1

5M

ar-1

5Ap

r-15

Apr-

15

60%

70%

80%

90%

100%

110%

120%

Exhibit 7. Muni to U.S. Treasury ratios (2014 - April 30, 2015)

5 YR 10 YR20 YR 30 YR

Refundings Drive Issuance to Over $144 Billion; Up 58% Year-To-DateSupply remained strong in April with issuance reaching $37.8 billion, the highest April issuance since 2008. As in prior months, refundings remain the driving force of debt issuance, comprising over 70% of year-to-date volume according to Ipreo MuniAnalytics. Demand, however, has been pressured (see Exhibit 8), with municipal bond fund outflows interrupting 38 consecutive weeks of inflows on the weeks of April 8 th and the 15th. This was not surprising, however, due to the April 15th tax deadline and low bond redemptions ($12.8 billion estimate vs. $23.7 billion monthly average), ultimately resulting in fewer investors in the market. Looking ahead, municipal bonds are entering one of if not their strongest seasons. The summer months have traditionally seen both significant issuance volume and available cash to invest given high levels of bond redemptions (an estimated $60 billion in May and June) and a slowdown in the

equities market.Advance Refundings and Their EscrowsAs noted earlier, issuers in 2015 have been taking advantage of favorable interest rates and undertaken current and/or advance refundings of existing debt. Unlike prior years, advance refundings comprise a significant percentage of refundings year-to-date: $48 billion – just $15 million shy of the total advance refundings completed in all of 2014 and greater than 2010 and 2011 year-end volume according to Ipreo MuniAnalytics (see Exhibit 9).

One factor that affects advance refundings is negative arbitrage, the different between the maximum allowable yield of the investments in the escrow (the arbitrage yield) and the actual yield of those investments. On one hand, low interest rates are a positive for issuers looking to refund existing debt; on the other hand, low interest rates also hurt advance refunding escrows.

In Exhibit 10 to the right, we have compared the difference between The Bond Buyer’s Revenue Bond Index (as proxy for the arbitrage yield) to the 5-year U.S. Treasury (as proxy for the escrow investment) from 1995 to the present. As the difference approaches zero, negative arbitrage is minimized and advance refundings are more attractive.

As the graph indicates, although negative arbitrage is well off lows during the 2009-era financial crisis, it is still far worse than before the crisis (i.e., from 1995 – 2007). That said, despite savings lost to negative arbitrage, issuers still choose to undertake advance refundings and lock in available debt service savings.

Jan-14

Feb-14

Mar-14

Apr-14

May-14

Jun-14

Jul-14

Aug-14

Sep-14

Oct-14

Nov-14

Dec-14

Jan-15

Feb-15

Mar-15

Apr-15

-5,000

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Exhibit 8. Muni issuance vs. muni bond flows

IssuanceBond Flows

Demand weakened in April as supply continued to hit year over year highs.

2010 2011 2012 2013 2014 As of 4/30/2015

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

$36,441,946$30,204,988

$84,289,526$57,506,945$62,989,192$48,028,418

$98,809,451$73,026,303

$97,824,984

$75,843,286$79,194,406

$29,824,868

$13,904,729

$17,201,690

$34,599,135

$22,556,696$41,130,909

$19,198,751

Exhibit 9. Advance refundings have made up nearly 50% of all refundings priced in 2015

AR Volume CR Volume AR/CR Volume

19951997

19992001

20032005

20072009

20112013

2015

-6.00%

-5.00%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%Exhibit 10. 5 YR U.S. Treasury spread to

Bond Buyer 25 Bond Revenue IndexAdvance Refund-ings MORE attrac-

tive

Large issues keeping coupons in the 5 – 5.25% rangeLarge issues made up over 20% of overall municipal issuance in the first four months of 2015: six issues each over $1 billion and 28 over $500 million. The graph in Exhibit 11 illustrates the size of municipal transactions year-to-date according to Ipreo MuniAnalytics.

Sizeable financings tend to attract institutional buyers, who demand higher coupons, particularly as protection against a future higher interest rate environment. Heavy issuance in recent months has also left deals competing for investors’ attention. Given these factors, 60% of new issue tax-exempt bonds year-to-date have carried 5 – 5.25% coupons.

Greater than $1 Billion

Less than or equal to $1 Billion; Greater than $500 Million

Less than or equal to $500 Million; Greater than $100 Million

Less than or equal to $100 Million; Greater than $50 Million

Less than or equal to $50 Million; Greater than $10 Million

Less than or equal to $10 Million

6

28

286

315

1,095

2,273

Exhibit 11. 2015 Bond issuance breakdown by number of issues

Final ThoughtsAs mentioned earlier, municipal bonds are entering their strongest season. They are a more favorable asset-class this year versus previous years as positive economic trends, increasing tax revenues and an improving housing market enhance municipal bonds’ credit quality (i.e., making them a “lower risk” investment). This favorability, combined with the weakness and volatility of the U.S. Treasury market, has kept demand high for municipals – at least for now.

COLUMBUS, OHIO

614.629.6950

DENVER, COLORADO

303.270.6330

HOUSTON,TEXAS

832.871.5291

LANSING, MICHIGAN

517.371.2483

MILWAUKEE, WISCONSIN

414.765.3827

MAHTOMEDI, MINNESOTA

612.499.3066

NAPERVILLE, ILLINOIS

630.778.9100

PHILADELPHIA, PENNSYLVANIA610.594.7080

ST. CHARLES, ILLINOIS

630.584.4994

TRAVERSE CITY, MICHIGAN

800.793.6379

WINSTON-SALEM, NORTH CAROLINA

336.631.5835

Advance Refundings LESS

attractive

Baird Public Finance

SOURCES: Department of US Treasury Website; Thomson Reuters MMD; the Bond Buyer; Baird Fixed Income Commentary (Tom Wammack); US Fixed Income Markets Weekly, JP Morgan; Baird Weekly Market Notes (Bruce Bittles, Chief Investment Strategist), Baird Municipal Bond Market Weekly (David Violette, Fixed Income Analyst); “Treasury SLGS Data Illustrates Shift in Market Composition;” (DIVER, April 20, 2015); Ipreo MuniAnalytics

Note: Bond Volume excludes short-term notes and private placements.

IMPORTANT DISCLOSURESBaird may from time to time have a proprietary position in the debt obligations of the issuers mentioned in the report. This report is for information purposes only and in no event should it be construed as a solicitation or offer to purchase or sell a security. The information presented herein is taken from sources believed to be reliable, but we do not guarantee the accuracy or completeness. Any issue named or rates mentioned are used for illustrative purposes only and may not represent specific features or securities available at a given time. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, securities prices, market indexes, operational or financial conditions of the issuers, or other factors. Past performance is not a guarantee on future performance. Preliminary Official Statements, Final Official Statements, or Prospectuses for new issues if mentioned herein are available upon request. For more information regarding municipal securities, visit emma.msrb.org. This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report. For investment advice specific to your situation, or for additional information, please contact your Robert W. Baird Financial Advisor and/or your tax or legal advisor.

Copyright 2015 Robert W. Baird & Co. Incorporated.

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