Muni investors weigh opportunity as smoke appears on horizon

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As Pennsylvania prepares to sell $1.39 billion of tobacco bonds next week, Invesco released a report that highlights reasons investors should own tobacco bonds.

Jefferies will price the Pennsylvania Commonwealth Financing Authority’s Series 2018 Tobacco Master Settlement Payment revenue bonds next week.

Invesco’s report, Tobacco bonds: An unfiltered look at a unique municipal asset class, says the benefits of tobacco bonds include: potential return enhancement; liquidity; inflation adjustment; and payments extending into perpetuity.

“Tobacco bonds are a predominately high-yield U.S. municipal asset class,” Invesco analysts Steve Hong, Allen Davis and Stephanie Larosiliere write in the report. “In 2017, high-yield tobacco bonds returned 22%, outpacing all other revenue sectors of the U.S. municipal market.”
Invesco said robust high-yield municipal bond fund flows and the demand for yield were the main drivers of last year’s strong performance.

While this year’s return potential may be limited on the back of 2017’s strong performance, Invesco said there were several other reasons to hold tobacco bonds.

“Tobacco bonds provide potential yield and total return enhancement over traditional general obligation and revenue municipal bonds,” Invesco writes. The analysts noted tobacco bonds are structured like asset-backed securities with various tranches that provide different risk and returns.

Tobacco bonds also accounted for $19.81 billion, or 19%, of the total rated high-yield debt in the U.S.

“Given the significant weighting of tobacco bonds within the high-yield municipal bond sector, there is demand throughout a credit cycle for tobacco bonds from both U.S. mutual funds and hedge funds.”

The 1998 Master Settlement Agreement provided for tobacco companies to make annual payments to the 52 states and territories signing on to it in perpetuity in return for dropping any future legal claims against the tobacco manufacturing companies.

Annual MSA payments are subject to inflation adjustment with a floor of 3%. Since 1999, 21 states and territories have securitized the MSA payments by selling tobacco bonds or transferring their rights to the MSA payments for an upfront fee.

Possible risks to the sector include the chances of greater-than-expected consumption declines; the possible bankruptcy of a tobacco company; failure of the states to enforce qualifying statutes; and the extension of prepayment risks.

Primary market
Municipal bond traders grabbed a “sensibly priced” sale from a New York issuer on Thursday as municipals weakened slightly in secondary trading.

In the competitive sector, New York’s Triborough Bridge and Tunnel Authority sold $351.93 million of Series 2018A general revenue bonds for the Metropolitan Transportation Authority’s bridges and tunnels.

Bank of America Merrill Lynch won the bonds with a true interest cost of 3.8348%.

The issue was priced to yield from 2.93% with a 5% coupon in 2043 to 3.28% with a 4% coupon in 2048.

The 2.93% 5s of 2043 and the 2.95% 5s of 2046 came in at about 20 basis points over the MMD AAA scale while the longer-dated 4s were about 50 basis points over the current MMD scale.

Traders said the deal was “sensibly priced” in light of the current weakness in the muni market.

The deal is rated Aa3 by Moody’s Investors Service and AA-minus by S&P Global Ratings and Fitch Ratings.

Prior to Thursday’s sale, the TBTA last competitively sold comparable bonds on May 30, 2012, when Citigroup won the $231.49 million of Series 2012A general revenue bonds with a true interest cost of 3.6057%.

Since 2008, the TBTA has sold about $10.9 billion of bonds, with the most issuance occurring in 2008 when it sold $2.19 billion and the least amount in 2010 when it sold $347 million.
Raymond James, acting as placement agent, priced Newark, N.J.’s $25 million of taxable redevelopment area bonds for the PSE&G project.

The deal is a private placement and was offered only to accredited investors. It was priced at par to yield 4.49% in 2047, or about 155 basis points over the comparable Treasury security. The issue has a make whole call provision at 30 basis points over the comparable Treasury.

The deal, which has a traveling institutional investor letter associated with it, is rated A3 by Moody’s.

Secondary market
The MBIS municipal non-callable 5% GO benchmark scale was mixed in late trading while the MBIS AAA scale was weaker.

The 10-year MBIS muni benchmark yield fell to 2.455% on Thursday from the final read of 2.477% on Wednesday, according to Municipal Bond Information Services. The MBIS 30-year benchmark muni yield rose to 2.904% from 2.883%.

The 10-year MBIS muni AAA yield rose to 2.354% on Thursday from the final read of 2.348% on Wednesday, according to Municipal Bond Information Services. The MBIS 30-year benchmark muni yield rose to 2.787% from 2.780%.

The MBIS benchmark index is updated hourly on the Bond Buyer Data Workstation.

Top-rated municipal bonds finished unchanged on Thursday. The yield on the 10-year benchmark muni general obligation was steady from 2.20% on Wednesday, while the 30-year GO yield gained was flat from 2.78%, according to the final read of MMD’s triple-A scale.

U.S. Treasuries were mixed in late activity. The yield on the two-year Treasury rose to 2.09% on Thursday from 2.08% on Wednesday, the 10-year Treasury yield dropped to 2.63% from 2.65% and the yield on the 30-year Treasury decreased to 2.89% from 2.93%.

On Thursday, the 10-year muni-to-Treasury ratio was calculated at 82.3% compared with 83.0% on Wednesday, while the 30-year muni-to-Treasury ratio stood at 95.4% versus 94.8%, according to MMD.

MSRB: Previous session's activity
The Municipal Securities Rulemaking Board reported 47,639 trades on Wednesday on volume of $11.94 billion.

California, Texas, and New York were the three states with the most trades on Tuesday, with the Golden State taking 13.98% of the market, the Lone Star State taking 9.429% and the Empire taking 9.29%.

Tax-exempt money market fund inflows
Tax-exempt money market funds experienced inflows of $1.68 billion, bringing total net assets to $137.80 billion in the week ended Jan. 22, according to The Money Fund Report, a service of

This followed an inflow of $719.3 million to $136.12 billion in the previous week.

The average, seven-day simple yield for the 198 weekly reporting tax-exempt funds fell to 0.75% from 0.86% the previous week.

The total net assets of the 833 weekly reporting taxable money funds increased $24.17 billion to $2.663 trillion in the week ended Jan. 23, after an outflow of $29.01 billion to $2.639 trillion the week before.

The average, seven-day simple yield for the taxable money funds increased to 0.96% from 0.94% from the prior week.

Overall, the combined total net assets of the 1,031 weekly reporting money funds increased $25.85 billion to $2.801 trillion in the week ended Jan. 23, after outflows of $28.29 billion to $2.775 trillion in the prior week.

Treasury announces auction dates
The Treasury Department announced the following auctions for next week: $48 billion of 91-day bills on Jan. 29; $42 billion of 182-day bills on Jan. 29; and $20 billion of 52-week bills on Jan. 30.

Treasury sells $28B of 7-year notes
The Treasury Department auctioned $28 billion of seven-year notes, with a 2 1/2% coupon and a 2.565% high yield, a price of 99.585928. The bid-to-cover ratio was 2.73.

Tenders at the high yield were allotted 26.08%. All competitive tenders at lower yields were accepted in full. The median yield was 2.525%. The low yield was 2.400%.

Gary Siegel contributed to this report.

Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation. Click here for a brief tour of the Workstation, or contact Vanessa Kim at 212-803-8474 for more information.

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Primary bond market Secondary bond market Municipal bond funds Tobacco Settlement Financing Corporation Railsplitter Tobacco Settlement Authority, IL Buckeye Tobacco Settlement Financing Authority Golden State Tobacco Securitization Corporation New Jersey Tobacco Settlement Finance Corp. Triborough Bridge and Tunnel Authority, NY State of California State of New York State of Texas City of Newark, NJ