Muni Update

September 5, 2017


In this week’s Municipal Market Update, we highlight the following:

 

Harvey

The effects of Hurricane Harvey will be felt by local governments in the Houston, Texas region for a while, as they now face unbudgeted costs for flood control, cleanup, sheltering individuals, emergency services, and rebuilding damaged infrastructure.  In addition, we note that some entities will face the risk of declines in their tax base, possibly long-term declines if people relocate elsewere and decide not to return. While we anticipate these costs will strain liquidity and increase debt issuance, the speed of reimbursements and rebuilding for those who stay, coupled with the amount and speed in the receipt and distribution of Federal Disaster Relief Payments will assist in the recovery, as most local governments will be eligible for aid from the Federal Emergency Management Agency (FEMA).

In order to receive FEMA reimbursements, the state has to issue a disaster declaration that must be approved by the federal government. On August 27, 2017, the Governor of the State of Texas, Greg Abbott, issued a declaration for 54 counties, including Harris County, home to Houston, all of which have been approved by the federal government. Declarations allow federal disaster assistance for individuals and public infrastructure, including funds for both emergency and permanent work.

The first round of federal funding is often reimbursements, usually at a rate of 100.0% for debris removal and emergency protective measures. The timing of this aid is of the utmost concern for local governments as oftentimes liquidity will be stressed by the need to make cash payments in advance of FEMA reimbursements. In addition, increased payroll demands due to public safety overtime and contracted debris collection are cash stressors. The other issue that could delay FEMA funding is that the FEMA’s Disaster Relief Fund seldom has a sufficient balance to fund recovery efforts on the scale of what will likely be needed for Harvey. Therefore, we expect that congressional support for supplemental appropriations will be critical going forward and should be strongly supported.

FEMA also provides financial assistance in the form of Community Disaster Loans (CDL). These loans, which typically may not exceed 25.0% of a locality’s (local government) budget or be in excess of $5.0MM, are meant to supplant lost operating revenues or increased operating costs due to a disaster declaration. While this type of aid is granted as a loan, CDLs have historically been forgiven. We note that the determination of forgiveness is not initiated for three years and is based upon FEMA’s assessment of the entity’s ability to repay.

Historically, U.S. municipal issuers have an extremely strong track record of recovering from natural disasters without bondholder impairment. The immediate disaster disruptions tend to cause short-term liquidity problems, which are often subsequently remediated by insurance payments, federal aid, state support and private charitable donations. Additionally, many governments have experienced increased sales tax revenues as rebuilding occurs.

This was the case after Hurricane Sandy brought widespread property damage to coastal communities in New Jersey and Long Island, New York. Many of the local governments undertook short-term borrowings to provide liquidity while awaiting FEMA reimbursement, while some others effectively ran deficits until reimbursements came. Ultimately, nearly all of the tax bases recovered and, in many cases, at even higher assessed valuations because many people took the opportunity to improve their properties beyond simple rebuilding. We view the Houston region and economy as desirable due to its exceptional economic opportunities, the strong presence of the petrochemical industry and its overall affordable cost. We would therefore expect the recovery to be as strong in the Houston Region as it was in the Northeast.

 

Municipal Market Recap

Municipal bond funds posted inflows for the sixth week, as weekly reporting funds experienced $344.518MM of inflows in the latest reporting week, after experiencing inflows of $750.500MM the week prior. The four-week moving average was positive at $578.250MM, after being in the green at $528.082MM the week prior. High demand is expected to continue to outpace supply in the municipal market, as the market is winding down a period of the heaviest volume of called and maturing bonds in any given year. This year the annual occurrence, which began June 1st, was expected to be record-breaking with over $100.0B of called and maturing bond proceeds, excluding coupon payments, slated to arrive into investors’ accounts over a three-month span. In addition, investors still facing negative rates overseas continue to find higher-yielding U.S. assets attractive. These factors should have both traditional and non-traditional market participants continuing to look for opportunities, especially if yields rise. While the uncertainty surrounding tax reform, infrastructure, and the pace of Fed tightening is causing some market participants to continue to be observers more than buyers at this time, retail participation remains strong.

U.S. Treasury prices started the trading week mixed, as the front- and long-end of the curve were steady and the 10-year spot strengthened. On Tuesday they were mixed again, as maturities 10 years and in strengthened, while the long-end was steady. Prices were mixed for a third day on Wednesday, as they weakened in the front-end and were steady 10 years and longer. On Thursday they continued the week’s trend and were once again mixed, as the front-end was steady and prices on maturities 10 years and longer strengthened. On Friday prices across the curve weakened. Prices on municipals started the trading week unchanged. On Tuesday prices strengthened across the curve. On Wednesday prices were steady. On Thursday prices were mixed, as bonds 10 years and in were steady, while the long-end strengthened. On Friday prices were mixed again, as the front-end was steady and bonds 10 years and longer weakened.

Volume for the trading week is projected to be $3.86B, which is well below last week’s revised level of $7.02B, but about average for a holiday-shortened trading week. Rates are stuck in a narrow range and municipal/U.S Treasury ratios remain very rich in the front-end and the belly of the curve, as there is much demand for short-dated paper in light of the uncertainty investor’s face in the fall. Still, we expect this level of issuance coupled with secondary market opportunities will address the continued strong demand in the municipal markets due to the current period of high redemptions.

Last week the yield on the two-year maturity on the MMD Triple-A Scale was unchanged from Thursday to Friday and ended the week at 0.85%. Meanwhile, the yield on the 10-year maturity rose two basis points (bps) and the yield on the 30-year maturity rose one bp on the MMD Triple-A Scale from Thursday to Friday, and they ended the week at 1.88% and 2.71%, respectively. Overall, week-over-week the yield on the two-year general obligation (GO) bond fell one bp, while the yield on the 10-year GO bond was unchanged and the yield on the 30-year GO bond fell two bps.

Last week the yields on the one-, two-, three-, five-, 15- and 30- year maturities on the MMA Triple-A Scale were all unchanged from Thursday to Friday and ended the week at 0.81%, 0.92%, 1.01%, 1.25%, 2.37% and 2.78%, respectively. Overall, week-over-week the yield on the two-year maturity tightened by one bp, while the yield on the 10-year maturity fell two bps and the yield on the 30-year maturity fell one bp.

Prices on U.S. Treasuries started last week mixed and were mixed daily through Thursday. On Friday prices weakened across the curve. Overall, week-over-week the yield on the 10-year maturity was unchanged and closed the week at 2.17%. Meanwhile the yield on the two-year maturity rose one bp week-over-week and closed the week at 1.34%. This resulted in a week-over-week 2s/10s spread of 83 bps, one bp tighter than last week’s 2s/10s spread of 84 bps. The yield on the 30-year maturity rose three bps week-over-week and finished the week at 2.78%.

 

New Issue Volume is Expected to be $3.86B

Total volume for the holiday-shortened trading week is estimated to be $3.86B, which is well below last week’s $7.02B in issuance, according to revised data from Thomson Reuters. This week’s calendar consists of $3.03B in negotiated deals and approximately $828.0MM in competitive sales, according to data from Thomson Reuters. There are only five scheduled sales that are $100.0MM or greater in par size, all coming from the negotiated arena.

The week’s largest deal will come from the New Jersey Economic Development Authority which plans to $595.0MM of motor vehicle surcharges subordinate revenue and taxable bonds. The deal is rated Baa2 by Moody’s Investors Service (Moody’s). Some of the issue is expected to be insured by Build America Mutual (BAM), which as of the date of this publication is not rated by Moody’s. So the expectation is the insured bonds will carry BAM’s Standard and Poor’s (S&P) insured rating of AA at closing.  The City and County of Honolulu, Hawaii plans to offer $350.0MM of rail transit project and floating-rate GO bonds. The deal is rated Aa1 by Moody’s and AA+ by Fitch Ratings (Fitch) and is expected to price on Tuesday. The Regents of the University of Texas plan to offer $350.0MM of taxable system revenue bonds on Thursday following indications of interest on Wednesday. The deal is rated triple-A by Moody’s, S&P, and Fitch, and it is anticipated to come as a bullet maturity in 2047.

In the competitive arena, the Pennsylvania Higher Educational Facilities Authority is scheduled to sell a total of $128.79MM in three separate sales on Wednesday. The taxable and tax-exempt state system of higher education revenue refunding bonds are rated Aa3 by Moody’s and AA- by Fitch.

 

Municipal Bond Funds Posted Inflows for the Week       

Municipal bond funds posted inflows for the sixth week, as market participants continued to put cash into funds, according to the latest data from Lipper. The weekly reporters saw $344.518MM of inflows in the week of August 16, after inflows of $750.500MM the week prior. The four-week moving average was positive at $578.250MM, after being in the green at $528.082MM the week prior.

Long-term municipal bond funds had inflows of $248.440MM in the latest week after inflows of $464.851MM the week prior. Intermediate-term funds had inflows of $35.870MM after inflows of $159.635MM the week prior. National funds had inflows of $339.475MM after inflows of $708.408MM the week prior. High-yield municipal funds reported inflows of $184.234MM in the latest week, after inflows of $235.522MM the week prior. Exchange traded funds reported inflows of $80.152MM, after experiencing inflows of $126.924MM the week prior. Ex-EFTs, municipal funds saw $264.366MM of inflows, after inflows of $623.576MM the week prior.

 

Demand in the Bank Qualified (BQ) Market Remains Strong

The new issue calendar for this holiday-shortened week is relatively light compared to last week. Participants will look to the secondary market for opportunities to pick up attractive structures in the steepest part of the curve (10+ years). Participants continue to utilize extension swaps and perform some portfolio cleanup, as the bid side for municipals continues to remain strong. The short-end (7 years and in) continues to perform extremely well due to the demand driven by the retail sector, thus making extension swaps extremely attractive with the ability to increase yield in the portfolio. Week-over-week, bank qualified municipal yields were relatively unchanged, while spreads were mixed throughout the curve. The short-to-intermediate part of the curve was relatively unchanged on a spread basis. The largest spread differential occurred on the long-end of the curve with the 15-year BQ municipal tightening seven bps on a spread-to-Treasury basis and the 30-year tightening 11 bps.

 

Daily Overview of the General Market for the Week Ending September 1st

Last Monday prices on municipals were steady, as market participants prepped for both the $6.87B in new bond issue offerings and the retail pricings of the $2.5B in State of California GO’s. On the day the yields on the two-, 10- and 30-year GO bonds were unchanged, according to the final read of the MMD Triple-A Scale.

Prices on U.S. Treasuries last Monday were mixed, as stocks failed to hold an opening bounce Monday and the Dow and S&P ended the day almost unchanged. The NASDAQ outperformed with a gain of 0.28%. Gas prices rose 3.7% Monday, expanding the spread between crude and gasoline to its widest since August 2015. The U.S. Dollar finished at session lows after a report that North Korea fired a missile over Japan boosted demand for the Yen. On the day, the yields on the two- and 30-year maturities were unchanged, while the yield on the 10-year maturity fell one bp. The 10-year municipal-to-Treasury ratio rose to 87.0% on Monday from the prior Friday’s level of 86.6%, while the 30-year municipal-to-Treasury ratio was unchanged on Monday from the prior Friday’s level of 99.3%.

Last Tuesday prices on municipals were stronger, as the bulk of the week’s issuance came to market, led by California’s $2.5B GO bond deal and the Greater Orlando Aviation Authority’s revenue bond offering. On the day the yield on the two-year GO bond fell one bp, while the yields on the 10- and 30-year GO bonds each fell two bps, according to the final read of the MMD Triple-A Scale.

Prices on U.S. Treasuries were mixed, as the flight to quality that began Monday evening after North Korea launched a missile over Japan, moderated ahead of U.S. trading on Tuesday morning. This moderation carried through the session resulting in stocks and the U.S. Dollar climbing back steadily throughout the day. The bid for the Yen also eased. In commodities, the focus remained on shuttered oil refiners. Gasoline prices rallied 6.0% Tuesday to their highest level in 25 months and crude prices fell 0.5% as Harvey headed toward Louisiana. On the day, the yield on the two-year maturity fell one bp, while the yield on the 10-year maturity fell two bps and the yield on the 30-year maturities was steady. The 10-year municipal-to-Treasury ratio was relatively unchanged from Monday’s level of 87.0%, while the 30-year municipal-to-Treasury ratio fell to 98.6% on Tuesday from Monday’s level of 99.3%.

Last Wednesday prices on municipals finished the day steady, as primary action dwindled down to the week’s last few deals ahead of the coming Labor Day Holiday. On the day, the yields on the two-, 10- and 30-year GO bonds were steady, according to the final read of the MMD Triple-A Scale.

U.S. Treasury prices finished the day mixed, as U.S. stocks overcame some early negativity and all three major indices moved higher Wednesday. The NASDAQ led the gains with a 1.05% rally and the S&P’s tech sector led the broader index to a 0.46% gain. The Dow climbed a more modest 0.12%. The U.S. Dollar climbed for almost the entire session and ended near its daily high. Gasoline prices rose more than 7.0% to their highest level since June 2015 as U.S. crude fell roughly 1.0%. On the day, the yield on the two-year maturity rose one bp, while the yields on the 10- and 30-year maturities were each unchanged. Both the 10- and 30-year municipal-to-Treasury ratios were unchanged on Wednesday from Tuesday’s levels of 87.0% and 98.6%, respectively.

Last Thursday prices on municipals finished mixed, as the market quieted down ahead of the Labor Day holiday weekend. On the day, the yields on the two- and 10-year GO bonds were unchanged, while the yield on the 30-year GO bond fell one bp, according to the final read of the MMD Triple-A Scale.

U.S. Treasury prices continued the weekly trend of being mixed, as U.S. stocks joined a global rally that pushed the major indices back towards record territory. The Dow added 0.25% (170 points shy of its record), as the S&P gained 0.57% (9 points shy of its record). The NASDAQ outperformed with a 0.95% jump that notched the index a new record close. The energy sector improved as crude prices rose for the first time this week. Gas prices rose 13.5%, an eighth consecutive daily gain and the sharpest in 18 months. On the day, the yield on the two-year maturity was unchanged, while the yield on the 10-year maturity fell one bp and the yield on the 30-year maturity fell two bps. The 10-year municipal-to-Treasury ratio rose to 87.3% on Thursday from Wednesday’s level of 87.0%, while the 30-year municipal-to-Treasury ratio rose to 98.9% on Thursday from Wednesday’s level of 98.6%.

Last Friday prices on municipals finished the week mixed, as market participants wound up the week ahead of the three-day holiday weekend, as the market is closed on Monday in observance of Labor Day. On the day, the yield on the two-year maturity was steady, while the yield on the 10-year maturity rose two bps and the yield on the 30-year maturity rose one bp, according to the final read of the MMD Triple-A Scale.

U.S. Treasuries prices finished the day weaker. On the day, the yield on the two-year maturity rose one bp, while the yield on the 10-year maturity rose four bps and the yield on the 30-year maturities rose five bps. The 10-year municipal-to-Treasury ratio fell to 86.6% on Friday from Thursday’s level of 87.3%, while the 30-year municipal-to-Treasury ratio fell to 97.5% on Friday, from Thursday’s level of 98.9%.





Dennis Porcaro

Senior Vice President

Vining Sparks IBG, L.P.

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