Market Close: Gross' Jump From Pimco Could Rock Tobacco

The departure of "Bond King" Bill Gross from Pimco could cause a sell-off in tobacco bonds backed by the Master Settlement Agreement, market participants said.

Gross left Pimco on Friday for Janus Capital, where he is expected to manage a new bond fund.

Pimco's holdings of MSA tobacco are near $500 million, Citigroup analysts wrote in a report released on Monday. Citi predicted Pimco's positions in MSA tobacco are large enough that Gross' decision to leave could "cause substantial market volatility" in the securities and index. Under the MSA, the largest tobacco agreed to reimburse states for the medical costs associated with smoking.

"As we see, these holdings would be substantial enough to cause a market dislocation across a number of municipal sectors/products if liquidated over a short period of time," Citi wrote in the report.

A trader on the west coast agreed with Citi's prediction and said that when investors see that some holders of any security, especially one with as much headline risk as tobacco, are selling the perception will be that those holders will start selling a lot.

He pointed to the crossover investors selling tobacco bonds over the summer as an example of this sheep mentality, and said that once other investors realized crossover buyers were exiting the trade they tried to unload the tobacco bonds, too.

"[Gross leaving] is definitely going to widen the bid-offer, given there's another unknown in the market," he said.

He said the three benchmark tobacco bonds people should watch are MSA New Jersey, Ohio, and California bonds.

"They're more correlated to risk than other bonds because they are owned by more taxable accounts," he said. "They're a little more correlated to the taxable spreads."

California's Golden State Tobacco Securitization Corp. tobacco settlement revenue 5s of 2033 and the Buckeye Ohio Tobacco Settlement Financing Authority 5.875s of 2047 were two of the most actively traded CUSIPs on Monday, according to Markit. Both traded weaker even as the broader muni market strengthened.

The yield on the Golden State Tobacco 5s of 2033 yield rose by two basis points to 6.72%, and that on the Buckeye Tobacco 5.875s of 2047 rose by one basis point to 7.73%, according to Markit.

Dick Larkin, senior vice president and director of credit analysis at HJ Sims, said in an interview that he thinks that all tobacco bonds are overpriced and money is running out.

Tobacco bonds sold since 2010 and 2011 are in "pretty good" shape, he said, because they have built in so much excess coverage they can withstand a lot of shocks.

Munis Strengthen, Following Treasuries

Municipal bond yields in the intermediate and the long ends of the curve fell on Monday, following the Treasury market.

Bonds maturing in six to eight years dropped by one basis point in yield, according to Municipal Market data. Nine to 30 year maturities' yields fell by two basis points, while the front end of the curve held steady.

The two-year held steady at 0.31%, according to Municipal Market Advisors. The 10-year's yield declined by two basis points to 2.18%, and the 30-year's by one basis point to 3.31%, MMA said.

Intermediate and long Treasuries' yields also declined, with the 30-year's yield dropping by four basis points to 3.18% and the 10-year by five basis points to 2.48% from market close on Friday.

The two-year notes' yield held steady at 0.59%.

Dorian Jamison, municipal credit analyst at Wells Fargo Advisors, said in an interview the tightening muni-to-Treasury ratio could cause a "pull-back" in the market, especially if the expense of munis is combined with increasing supply.

"From a technical standpoint, the market does seem somewhat overbought," he said.

This week's volume is expected to total $5.3 billion, according to data provided by The Bond Buyer and Ipreo. This is lower than last week's $8.4 billion total issuance, but still higher than weekly volume had been averaging through the summer.

The trader on the west coast said that investors are currently concerned about where to put their money.

Treasuries began falling last week as tensions in the Middle East worsened after President Barak Obama ordered an airstrike on Islamic extremists in Syria on the 23rd. President Obama then said in a speech to the United Nations on the 24th the U.S. military would work with allies to dismantle the Islamic State's "network of death."

Traders told The Bond Buyer the president's more aggressive approach to the situation with ISIS would cause investors to flee to "safe haven" Treasuries, making the notes strengthen. They also predicted this strength would bleed into the municipal market.

Lipper Data Indicates Market Will Stay Stable

Jamison pointed to last week's high fund flows as a positive sign that even if there is a pull back, demand for munis will remain strong overall.

Inflows for all municipal bond funds increased by nearly 200% for the week ending September 24, according to Lipper FMI.

Inflows totaled $588.77 million last week, up from $196.57 million the previous week.

"Two weeks ago we saw the smallest inflow in a month in a half about, but then we did see that pick up last week," he said. "My view is that demand is still strong and still a strong appetite for the increased supply we have seen."

High yield fund inflows grew to $261.82 million from $101.1 million the week before. Assets increased to $468.5 billion from $464.3 billion. The four-week moving average was $175.7 million, up from $167.7 million.

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