The top five trends in the municipal market place in 2018 will be the acceleration of taxable municipal issuance; the outperformance of high-yield municipal bonds; the underperformance of intermediate municipal bonds; the fall of tax-exempt municipal to Treasury ratios to 20-year lows; and the decline of tax-exempt market liquidity, according to a forecast released by MacKay Municipal Managers on Monday.
The year ahead offers both risk and rewards, said the MacKay municipal bond team.
“The traditional approach of being a passive investor focused solely on income is no longer suitable,” John Loffredo and Robert DiMella, co-heads of MacKay said in a market comment released on Monday. “Tax reform and new regulatory policies will present investment opportunities for well-positioned municipal investors, but also increase the risk for those who fail to adjust to the new investment environment.”
MacKay said it expects taxable muni issuance could double to approximately $60 billion annually. “We believe that low rates, tight credit spreads and demand for yield should keep taxable municipal yields low. Issuers will likely refinance their higher cost tax-exempt debt with taxable municipal bonds, overcoming the elimination of tax-exempt financed advance refundings by the Tax Cuts and Jobs Act of 2017. The increased volume of taxable municipal bonds should broaden the investor base for these securities, increase liquidity, and provide attractive yield opportunities. Individual investors in high tax states where the top marginal rate is quickly reached may also find in-state taxable municipal bonds, still exempt at the state level, to be attractive.”
MacKay also said it expects favorable technical and improving fundamental conditions will result in tighter high-yield muni credit spreads and outperformance relative to investment-grade municipal bonds.
Conversely, low yields, interest-rate sensitivity, the correlation to Treasury yields, and curve flattening will result in underperformance of higher quality intermediate municipal bonds, MacKay said.“We anticipate higher short-term yields and diminished demand in intermediate municipal bonds by banks and property and casualty insurance companies will lead to a flatter curve,” according to the report.
MacKay expects the muni/Treasury ratios will decline due to supply/demand technicals and improving fundamental conditions. "As a result, we anticipate that tax-exempt municipal bonds will outperform Treasury bonds and other high-quality taxable bonds,” MacKay said.
Finally, MacKay said it believes liquidity for tax-exempt municipals will decline and volatility will rise.
“Lower corporate tax rates will reduce the profitability of trading tax-exempt debt for broker-dealers, leading to a reduction in trading capital committed to the municipal market,” the report said. “As a result, they will likely redeploy capital into the taxable markets to generate trading profits. For capital still committed to the municipal market, we expect broker-dealers to prefer rated, liquid names as the capital cost of positioning non-rated paper will be prohibitive. As a result, non-rated bonds will trade primarily on an agency basis, where the broker will only transact with the seller and buyer simultaneously. We believe this will further reduce their liquidity and, most likely, value.”
MacKay Municipal Managers is the municipal bond team of investment management company MacKay Shields LLC, which is an indirect wholly owned subsidiary of New York Life Insurance Co. and a wholly owned subsidiary of New York Life Investment Management Holdings LLC. It has $113 billion in assets under management as of Nov. 30, 2017, which reflects the addition of the Cornerstone Capital Management Holdings LLC’s investment teams that joined MacKay on Jan. 1. MacKay manages fixed income and equity strategies for high-net worth individuals, institutional clients and mutual funds.
The MBIS municipal non-callable 5% GO benchmark scale was stronger in early trading.
The 10-year muni benchmark yield fell to 2.366% on Tuesday from the final read of 2.390% on Monday, according to Municipal Bond Information Services. The MBIS 30-year benchmark muni yield dropped to 2.848% from 2.854%.
The MBIS benchmark index is updated hourly on the Bond Buyer Data Workstation.
Top-rated municipal bonds were mixed in early activity. The yield on the 10-year benchmark muni general obligation rose as much as two basis points from 2.14% on Monday, while the 30-year GO yield was unchanged from 2.74%, according to a read of MMD’s triple-A scale.
U.S. Treasuries were narrowly mixed on Tuesday. The yield on the two-year Treasury was flat from 2.07% on Monday, the 10-year Treasury yield dropped to 2.63% from 2.66% and the yield on the 30-year Treasury decreased to 2.89% from 2.93%.
On Monday, the 10-year muni-to-Treasury ratio was calculated at 80.5% compared with 80.8% on Friday, while the 30-year muni-to-Treasury ratio stood at 93.6% versus 93.8%, according to MMD.
MSRB: Previous session's activity
The Municipal Securities Rulemaking Board reported 39,630 trades on Monday on volume of $9.09 billion.
Texas, California, and New York made up the top three states with the most trades on Monday with the Lone Star State taking 11.294% of the market, the Golden State taking 10.724% and the Empire State taking 9.141%.
BlackRock’s portfolio helped by healthcare, transportation and tobacco
BlackRock, which oversees about $124 billion of municipal debt, put out its monthly report late on Monday afternoon and said the fund posted a strong positive return in December, driven by a longer duration posture, sector allocation and security selection.
“Allocations to the healthcare, transportation and tobacco sectors contributed positively, as did security selection within utilities and state tax-backed,” wrote Peter Hayes, head of the municipal group at BlackRock and portfolio manager of the Strategic Municipal Opportunities Fund, a 5-star fund that adapts to changing municipal markets. “From a yield curve perspective, an overweight in the 20-plus year space added to performance. Exposure to high yield and taxable muni bonds also proved beneficial. Detracting from performance were the fund’s underweight positions in the 0- to 1-year and 8- to 9-year parts of the curve.”
He also added that in December, they started with a pro-risk stance as they took advantage of attractively priced opportunities in the primary market.
“After the tax reform was signed later in the month, we moved to a more defensive posture as we expect rates to move higher amid stronger global growth, less accommodative policy from developed-market central banks and strengthening inflation. We reduced the fund’s duration and increased cash. From a yield curve perspective, we increased exposure to the 0- to 3-year part of the curve while reducing exposure to 15 years and out.”
Goldman Sachs is set to price the Sales Tax Securitization Corp.’s $366.2 million of tax-exempt bonds and $300 million of taxables
On Monday, underwriters distributed a pre-marketing wire on the tax-exempts and offered spreads to the Municipal Market Data’s AAA benchmark scale of 55 basis point on serials ranging from 2031 to 2038.
The term bonds for $91.75 million in 2043 and $117 million in 2048 offered a spread of 60 basis points with a 5% coupon and a 95 basis point spread with a 4% coupon. The other spreads are based on 5% coupons. The syndicate was also seeking buyer input on a preference for a 4% or 5% coupon on the 2048 term bond.
Details on the $300 million taxables, which are due in 2048 with a make-whole call feature, were not available.
The deal is rated AA by S&P Global Ratings and AAA by Fitch Ratings and Kroll Bond Rating Agency.
On Tuesday, Goldman will price for retail investors the state of Connecticut’s $800 million of Series 2018A special tax obligation bonds for transportation infrastructure purposes. The deal is rated AA by S&P, A-plus by Fitch and AA-plus by Kroll.
Bank of America Merrill Lynch is set to price the Port Authority of New York and New Jersey’s $832 million deal, consisting of $677 million of 207th Series of consolidated bonds subject to the alternative minimum tax and $155 million of taxable 208th Series consolidated bonds on Tuesday.
The deal is rated triple-A by Moody’s Investors Service and S&P.
Since 2008, the PANYNJ has sold about $21.89 billion of bonds, with the most issuance occurring in 2012 when it sold $3.69 billion and the least amount in 2016 when it sold $1.10 billion.
Also, BAML is expected to price the Maryland Stadium Authority’s $426 million of revenue bonds for the Baltimore City Public Schools’ construction and revitalization program on Tuesday.
The deal is rated Aa3 by Moody’s, AA-minus by S&P and AA by Fitch.
Additionally, BAML is set to price for retail the Massachusetts School Building Authority’s $395 million of Series 2018A subordinated dedicated sales tax bonds on Tuesday.
The deal is rated Aa3 by Moody’s, AA by S&P and AA-plus by Fitch.
And BAML is expected to price for retail the city and county of Honolulu’s $305 million of wastewater system revenue bonds, consisting of: Senior Series 2018A&B first bond resolution refunding bonds; and Junior Series 2018A taxable and Series 2018B refunding second bond resolution bonds.
The senior bonds are rated Aa2 by Moody’s and AA by Fitch and the junior bonds are rated Aa3 by Moody’s and AA-minus by Fitch.
On Tuesday, the University of Washington will competitively sell $135.99 million of Series 2018 general revenue bonds.
The deal is rated Aaa by Moody’s and AA-plus by S&P.
Bond Buyer 30-day visible supply at $9.23B
The Bond Buyer's 30-day visible supply calendar decreased $282.5 million to $9.23 billion on Tuesday. The total is comprised of $2.25 billion of competitive sales and $6.98 billion of negotiated deals.
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.