A dramatic plunge in yields yesterday continued a two-day surge as the municipal market roared back to life with a staggering rally that saw huge demand for bonds in both retail and institutional sectors.
The Bond Buyer 40 Municipal Bond Index rose 4-26/32 - its largest one-day increase since the index began in 1984. The previous record was Tuesday, when it rose 2-25/32. Before that, it was 2-21/32 for the original version of the Index on April 16, 1987.
The declines of 69 basis points in the average yield to par call and 38 basis points in the average yield to maturity were also the largest one-day drops on record. The previous records were set on Oct. 20, 1987, when the yield to par call fell 44 basis points, to 10.05% and the yield to maturity fell 32 basis points to 9.37%.
Yesterday's trading session also saw several large deals come to market to take advantage of the much lower rates, some ahead of schedule, as tax-exempt yields plummeted by 15 to 20 basis points on average, with munis firming as much as 25 basis points on the long end, according to traders.
Evan Rourke, portfolio manager at MD Sass, said the rally seems to be "broadly based."
"We seem to be seeing it from all different areas. We had at least one big crossover buyer, but it seems like there are other buyers all around," Rourke said. "Late last week into early this week, it seems there has been a feeling to sell 5s to buy better structure when the new issues come. But then this rally may have caught some of those people flat-footed, so some people may have oversold a bit, and are now scrambling a bit to put money to work. But we certainly feel pretty good right now."
Michael Pietronico, chief executive officer at Miller Tabak Asset Management, said that both the sell-off in the last month, and "the reversal in the market's fortune" yesterday and Tuesday, is "very much linked to Libor."
"Tell me what Libor is going to be in three or four weeks, and I'll tell you where rates will be," Pietronico said. "The asset class is too cheap relative to the Treasury market, that's for sure. The question is, does Libor behave? And that's open to interpretation. The immediate expectation is that Libor is trending down, and that takes the pressure off leveraged accounts to sell.
"The sell-off in September and this month didn't seem that fundamental at the time; it seemed more like a credit event, in regards to funding," he added. "So as long as funding costs come under control, I can't see any reason why this rally shouldn't continue. The market got to yields that were unsustainable, and given the high quality nature of the asset class, I would expect the rally to continue as long as Libor behaves."
Rourke agrees that the rally "could continue for a while."
"Because of relative cheapness, we're still attractive," he said. "Munis at a 6% were very, very cheap, but even long munis at a 5% in the current environment are still pretty attractive, especially when you look at them on an alternative investment basis.
"There's a pent-up calendar, though, and if that comes through all at once, you may have a problem," Rourke added. "I think what we're going to see going forward is that liquidity is different than it used to be. With the loss of some dealers and arb accounts, and you're just going to see kind of a different world. Munis may have hellacious sell-offs, followed by gapping-up rallies, and that just might be the way it is."
Rourke also said that the rally was "really accelerated when you saw institutions start to participate as well, because they have the firepower to really move the market faster."
"Not that retail wasn't doing tremendous volume. The retail bid on the new issues helped make that happen," he said. "In some cases, institutions were barely able to buy bonds because retail orders were so strong."
"Retail demand has just been overwhelming," Pietronico said. "As we rally some more, I think you'll find that institutions might be selective sellers. But it's retail that's really driving the market both up and down, and right now they seem to be buyers."
Dominick Mondi, senior managing director of municipal trading at Mesirow Financial in Chicago, believes the rally stemmed from an end to deleveraging and a "roar" of retail buyers into the market at the fastest pace in a generation.
"The key ingredient in munis is that they've always had a foothold in retail investors [who] came in and bought a ton of very attractive bonds," Mondi said.
As mutual and hedge funds were forced to sell assets from deleveraging and liquidity pressures, the muni market experienced 18 days of falling prices. The selloff sent short-term debt "rocketing down" and created a "perfect storm" for retail buyers, according to Mondi.
Investors have been selective and are "extremely credit conscious," he said. If investors continue to buy attractive yields at the A-rated and lower quality levels, the rally could be sustainable, Mondi said. But the deleveraging has diminished and $19 billion in pent-up new issuances will come into the market, he said.
"The muni market is very frisky," a trader in New York said. "The return to order has become a major market rally."
In the new-issue market yesterday, M.R. Beal & Co. priced $536 million of first resolution bonds for the New York City Municipal Water Authority. The issuer began a retail order period Tuesday, which continued through institutional pricing yesterday. At re-pricing, yields were reduced by 13 basis points in 2017, 15 basis points from 2019 through 2022 and in 2024, and by 45 basis points in 2040. Yields in final pricing ranged from 4.87% in 2017 to 5.90% in 2040. The credit is rated Aa2 by Moody's Investors Service, AAA by Standard & Poor's, and AA by Fitch Ratings.
Thomas Paolicelli, executive director of the authority, said about $200 million of the deal went to institutional buyers, while $336 million went to retail. Institutional buyers mostly bought from a $390 million 2040 maturity.
"We had a great day," Paolicelli said. "Municipals continue to be a very safe investment and perhaps retail investors are looking for that quality that they can't find elsewhere right now."
Siebert, Brandford Shank & Co. priced $500 million of general obligation bonds for Connecticut. The bonds mature from 2009 through 2028, with yields ranging from 2.10% with a 3.5% coupon in 2009 to 5.23% with a 5.25% coupon in 2028. Yields were selectively lowered by five to 23 basis points at re-pricing. The bonds, which are callable at par in 2018, are rated Aa3 by Moody's and AA by Standard & Poor's and Fitch.
Goldman, Sachs & Co. priced $410.8 million of bonds for the South Carolina Public Service Authority, known as Santee Cooper. The deal was originally slated to be priced for retail investors yesterday, with institutional pricing today, but the schedule was accelerated. It was also up-sized at re-pricing from $308.1 million, while yields were lowered roughly 15 to 20 basis points. The bonds mature from 2010 through 2012, from 2015 through 2018, with term bonds in 2023, 2028, and 2038. Yields range from 3.00% with a 5% coupon in 2010 to 5.75% priced at par in 2038. The bonds, which are callable at par in 2019, are rated Aa2 by Moody's, AA-minus by Standard & Poor's, and AA by Fitch.
Merrill Lynch & Co. priced $296 million of revenue bonds for the California Health Facilities Financing Authority.
The Treasury market likewise showed sizeable gains. The yield on the benchmark 10-year Treasury note, which opened at 3.74%, finished at 3.60%. The yield on the two-year note, which opened at 1.61%, finished at 1.52%. The yield on the 30-year Treasury bond, which opened at 4.22%, finished at 4.06%.
Patrick Temple-West and Ted Phillips contributed to this column.