Flight Risk, Supply Drought May Ease
The municipal bond market turned in a very quiet session Friday ahead of a mild supply test this week.
The Municipal Market Data scale weakened a basis point or two for intermediate maturities but was otherwise unchanged. The 10-year yield ticked up two basis points to 2.93%, while the 30-year held in at 4.68%.
One trader in New Jersey said nobody was chasing bonds, and he got the feeling buyers were “just kind of regrouping” following the 10-basis-point rally earlier in the week.
Both the factors that bolstered municipals last week — a flight from risk in broader financial markets and the continuing supply drought — might be out of play this week.
The flight to safety partially unwound on Thursday and Friday, with Treasury yields picking back up 10 basis points and the S&P 500 Index rallying 1.8%. The bid for municipals based on risk-aversion appears to have run its course.
The Street will get something of a mini-test of its ability to absorb new supply next week, with issuers scheduled to sell $4.4 billion of debt. New York State looms with an $830 million deal and Massachusetts plans a $438.5 million sale.
If it’s not a full-blown test — we’ll call it a quiz. While not a heavy slate by historical standards, $4.4 billion is well above the 2011 trend.
The trader in New Jersey said one week with $4.4 billion of issuance is not going to change the supply-demand balance. Several weeks might.
In the meantime, municipals continue to benefit from scarcity.
“There’s no pressure; there’s no reason for us to have to sell,” the trader said. “There’s still only so much around in Muni Land. ... If we get another couple of weeks with this much coming, then we will have some concerns.”
John Compton, who heads underwriting at Crews & Associates, said bankers are having little trouble placing bonds now, amid the light supply. He’s not sure bonds would be absorbed so readily with a heavier supply. It’s not that buyers would be nonexistent; it’s just that municipalities might have to pay more to attract investors.
“It won’t be harder to find buyers; it just might take more yield,” Compton said. “A buyer can always be found at a price.”
The yield curve might have to steepen with a heftier supply of new bonds, he said.
The story lately is that the market is shrinking. While demand for municipal debt has shrunk, the supply of municipal debt has shrunk even more.
Municipalities are on their way to their first sub-$50-billion quarter of issuance since 2000.
There’s still a feeling-out process taking place, in which the sell-side is figuring out how much capacity the buy-side has to take on bonds.
With a bevy of Republican governors taking office this year on a pledge of fiscal probity, issuers have yet to test the limits of demand.
“The underwriters have felt fairly insulated in terms of the low volume,” said Jaime Durando, who heads municipal debt syndication at RBC Capital Markets. “In terms of the buyers out there, I wouldn’t say that it’s a robust market. … I don’t think by and large it’s an entry point in the marketplace where the full scale of institutional investors feel it’s a place to jump in with both feet.”
It all comes down to supply, Durando said. If municipalities go the whole year borrowing less than $300 billion, “the concerns don’t have to be as significant.”
We’re glad Moody’s Investors Service reiterated a negative outlook for local governments earlier this week because it allows us to spotlight just how terrifying a “negative” outlook in this market is. Namely, not at all terrifying.
Moody’s expects a “modest increase” in defaults this year. Considering all the talk lately of municipals morphing from an interest-rate product to a credit-spread product, we’d like to contemplate what a modest increase in defaults would look like.
Using the Moody’s default study published last year, we note that every single rated municipal default since 1970 is listed in a table that fills less than two pages. And it’s not like they used a tiny font.
Because, we assume, it would lead to the death of too many trees to list every corporate default over the past 40 years, in the comparable corporate study they list only the defaults that took place in 2009. It takes up 11 pages.
Yes, corporate defaults in 2009 alone were more than five times the number of municipal defaults over the past 40 years.
Sure, only a fool extrapolates the past unadulterated into the future. So as a thought exercise let’s assume that by “modest increase” in defaults, Moody’s means defaults will increase 100-fold. That would mean that instead of one out of every 10,000 credits defaulting annually on average, it would be one out of every 100.
After this modest increase in defaults, would you rather be in corporate bonds, which every year on average sustain one default per 64 issuers?
Proxies for the Market
Our thanks to Municipal Market Advisors’ Tom Doe, who at a panel we moderated on Thursday pointed out the folly of citing the iShares S&P National AMT-Free Bond Fund, an exchange-traded fund with less than $2 billion in assets, as a proxy for the municipal market, when thoroughly diversified mutual funds like the $27.9 billion Vanguard Intermediate-Term Tax-Exempt Fund or the $10.2 billion Franklin Federal Tax-Free Income Fund publish their net asset values daily.
If you noticed us fidgeting after that, it’s probably because we are wholly guilty of this transgression, which we assure you will not be repeated.
Our only saving grace really is that the iShares fund, whose ticker is MUB, is heavily discussed in the blogosphere, while the biggest municipal bond mutual funds, with multiples of the entire municipal ETF industry’s assets, go mostly unnoticed.
On the Yahoo! Finance, MUB’s page features five news headlines from last week alone. The mammoth Vanguard fund has not had one all month.