Muni reinvestment expected to dominate in coming months
Municipal bond buyers headed back into the market on Tuesday, awaiting a small post-holiday supply calendar.
Reinvestment to dominate activity
Market activity over the next several weeks and months will be dominated by investors working to reinvest the proceeds of their maturing and called municipal bonds.
“On June 1, we expect that $20.2 billion in bonds will be redeemed, out of an estimated total of $46.2 billion for the month,” said Patrick Luby, senior municipal strategist at CreditSights. “To place that in context, new-issue supply is on pace to be averaging $26 billion per month.”
He added that the June 1 redemption flows will be heaviest in Pennsylvania, Florida, California, Iowa and North Carolina and that a significant portion of the June redemptions will be from short-term borrowings. "Our preliminary estimate is that $11.6 billion in notes will mature in the month, led by issuers in California, New York, New Jersey and Colorado," he said.
Supply will not get much of a boost this week, with only $3.2 billion of long-term issuance expected, and next week's supply is currently pegged at $2.4 billion, but Luby said that number is likely to be higher than that.
"The expected issuance this week is almost 50% lower than the year-to-date weekly average volume of $6.1 billion, but does include several interesting offerings."
He also noted that the SIFMA Index, which tracks the yields on seven-day municipal variable-rate demand obligations, fell again last week, even though the total par amount of VRDOs offered on Bloomberg rose to $6.6 billion as of Friday up from $3.4 billion on May 17. The recent low amount was set on May 7 when only $644 million were offered.
In response to money market mutual funds losing $1.7 billion in assets in the week ended May 22, Luby said the total amount of negative yielding debt in the Bloomberg Barclays Global Aggregate Index rose again last week to $10.671 trillion, after peaking the week before at $10.609 trillion. "For non-U.S. investors, municipal bond yields may hold some allure, but offshore buyers have typically favored large index-eligible bonds- which are in short-supply this week," he said.
Morgan Stanley’s muni strategy playbook
Munis have become mostly rich and are now offering weak excess returns, according to strategists from Morgan Stanley.
“The 'late-cycle haven' helps keep ratios and spreads in a range, but in this 'last leg' it's prudent to limit exposure,” said a report from Michael Zezas, Mark Schmidt and Alexander Ventriglia. “Traditional buyers outside high-tax states: use new money to pair longer munis and shorter U.S. Treasuries; crossovers should reduce.”
The report said that in many ways, munis have now become fully valued.
“The run driven by the ‘late-cycle haven’ dynamic has been impressive for munis over the past 12 months — total returns of 6.6%, excess returns of 0.5% for investment-grade munis and 13% lower in 10-year and 30-year ratios,” the report said. “But the resulting valuations are now too tight to justify many investors putting new money into munis. With an implied tax rate of 39% in 10-years and 32% in 30-years, the intrinsic value of the tax-exemption has long been priced in for banks and insurance companies and now for individuals appears fully priced in except on the long-end of the curve.”
The strategists said it was their view that there was no good reason to overpay for munis.
“Munis are a solid diversifier but not materially different than other high-quality duration options like Treasuries,” they said.
However, the strategists said they are moving their recommendations for taxable munis to equal weight from underweight.
“We move to equal weight for two reasons. First, investor demand for high-quality corporate alternatives has proven much stronger and long-lasting that we anticipated,” they said. “Second, we think munis’ better credit quality relative to corporates may stand out if credit spreads widen as our corporate colleagues forecast.”
Morgan Stanley began the year underweight taxables.
“Given how much taxable muni spreads had tightened, we thought it made sense to take profits,” they said. “But broad-mandate taxable investors we talk to appear to be more wary of higher corporate leverage and are looking to diversify into high-quality credit that still offers a good spread to Treasuries.”
Morgan Stanley noted that taxable munis offer a shelter from corporate credit risks — AA and AAA munis have historically been downgraded at between one-third and one-half the rate of corporates. And taxable munis still offer a good spread to Treasuries, with 10-year AAA munis yielding about 100 basis points over the comparable Treasury, they said.
They cautioned that they could be wrong.
“Taxable munis may offer a higher credit quality alternative to corporates, but that doesn’t mean taxable munis won’t widen in sympathy with corporate credit during a selloff. In fact, a shaky market could increase illiquidity premiums,” the report said.
Last week's actively traded issues
Revenue bonds made up 50.73% of total new issuance in the week ended May 24, down from 53.14% in the prior week, according to IHS Markit. General obligation bonds were 44.95%, up from 42.23%, while taxable bonds accounted for 4.32%, down from 4.63%.
Some of the most actively traded munis by type in the week were from Georgia, Arkansas and California issuers.
In the GO bond sector, the Fulton County, Ga., 2.5s of 2019 traded 24 times. In the revenue bond sector, the Arkansas Development Finance Authority 4.5s of 2049 traded 42 times. In the taxable bond sector, the Inland Empire Tobacco Securitization Authority, Calif., 3.678s of 2038 traded 37 times.
This week’s supply is estimated at $2.8 billion, consisting of $1.8 billon of negotiated deals and $935 million of competitive sales.
Goldman Sachs is set to price the Port of Port Arthur Navigation District of Jefferson County, Texas’ (Aaa-VMIG1/NR/NR) $315 million of Series 2018 exempt facilities revenue bonds for Emerald Renewable Diesel as a remarketing.
Susquehanna Group Advisors is the financial advisor; McCall Parkhurst & Horton is the bond counsel. The bonds, due June 1, 2049, are subject to a mandatory tender on Oct. 3.
Morgan Stanley is expected to price the North Orange County Community College District of Orange and Los Angeles Counties, Calif.’s (Aa1/AA+/NR) $150 million of Election of 2014 Series B general obligation bonds on Wednesday.
BofA Securities is set to price the Chandler Industrial Development Authority, Ariz.’s (A1/A+/NR) $500 million of Series 2019 industrial development revenue bonds for Intel Corp. on Thursday.
The bonds are due June 1, 2049. Proceeds will be used to finance the acquisition, construction and installation of industrial sewage and wastewater treatment facilities at Intel’s plant in Chandler. Squire Patton Boggs is the bond counsel; Wells Fargo Bank is trustee.
In the competitive arena, the Metropolitan Water District of Southern California (NR/AAA/AA+) is selling $220.4 million of Series 2019A water revenue refunding bonds on Wednesday.
Proceeds will be used to current refund some outstanding debt. Public Resources Advisory Group is the financial advisors; Stradling Yocca and Alexis S.M. Chiu are the bond counsel.
Also on Wednesday, Hillsborough County, Fla., will sell $134.32 million of Series 2019 capital improvement non-ad valorem revenue bonds.
Proceeds will be used to finance and/or reimburse the costs of the acquisition, construction, reconstruction, expansion and equipping of various capital projects. Public Resources Advisory Group is the financial advisor; Bryant Miller and Llorente & Heckler are the bond counsel.
Light activity in post-holiday market
The few new issues that came into the post-holiday municipal market on Tuesday were well subscribed for and saw decent repricings, according to a Florida trader, who did note however that there was a lackluster feeling otherwise.
“There are a lot of people who chose to take an additional day of vacation — it’s a very quiet and listless trading day,” the trader said Tuesday afternoon, pointing to a Lubbock, Texas, Permanent School Fund $56 million deal as one of the issues that got some attention.
Overall, the secondary market under-performed Treasuries and municipals faced some struggles. “There are not enough players to keep up with the gains we are seeing in the rate space,” he said.
With just a little less than $3 billion in new volume this week, investors were not impressed with municipals.
“Today, out of the chute there are not many deals pricing, but tomorrow and Thursday is when you will see most of the meat” this week, he noted.
“Rich valuations are reverting back to being a little cheaper — and as that plays out, with this rate rally we have seen over the last 10 or so trading sessions, buyers will probably re-engage in the market,” the trader said.
However, he said there may be a delay in their renewed participation. “Until customers are comfortable to come back in the market I don’t think we will really see where the demand component will be."
At the same time, June 1 redemptions are around the corner and will help boost demand — despite the expectations of continued low supply. “There is a significant amount of net negative supply expected between June and August, so investors will have money to put to work,” he said.
However, an imbalance will occur when the expected supply meets the amount of reinvestment dollars from maturing cash and coupon payments, he noted. “There will be too much demand for the amount of supply coming into the marketplace,” the trader said.
Overall, municipals will be an active place for investors to reinvest their cash, but some may choose to wait it out before jumping in with two feet. “Some of the demand is based on the current richness of munis — but some investors will be sidelined for the moment until they feel more comfortable,” he added.
Munis were mixed on the MBIS benchmark scale Tuesday, which showed yields rising one basis point in the 10-year maturity and remaining unchanged in the 30-year maturity. High-grade munis were weaker, with yields rising by one basis point in the 10-year maturity and by less than a basis point in the 30-year maturity.
On Refinitiv Municipal Market Data’s AAA benchmark scale, the yield on the 10-year muni GOs fell one basis point to 1.71% while the yield on the 30-year muni fell one basis point to 2.41%.
The 10-year muni-to-Treasury ratio was calculated at 75.5% while the 30-year muni-to-Treasury ratio stood at 89.1%, according to MMD.
It was a quiet start to the short trading week with subdued volumes after the Memorial Day weekend, ICE Data Services said in a Tuesday market comment.
“The ICE muni yield curve is hovering around Friday’s levels to start the week. High-yield and tobaccos are similarly unchanged, along with Puerto Rico,” IDS said. “The taxable side of the market is following Treasuries with yields dropping by four to five basis points in the five- and 10-year maturities.”
Treasuries were stronger as stock prices traded mixed. In late Treasury trade, the three-month was yielding 2.360%, the two-year was yielding 2.129%, the 10-year was yielding 2.267% and the 30-year was yielding 2.704%.
Previous session's activity
The MSRB reported 19,624 trades on day on volume of $8.77 billion. The 30-day average trade summary showed on a par amount basis of $12.52 million that customers bought $6.16 million, customers sold $4.19million and interdealer trades totaled $2.17 million.
California, Texas and New York were most traded, with the Golden State taking 12.627% of the market, the Lone Star State taking 11.057% and the Empire State taking 10.439%.
The most actively traded security was the Wisconsin Health and Educational Facilities Authority revenue 4s of 2043, which traded 12 times on volume of $29.13 million.
Treasury auctions bills, notes
The Treasury Department Tuesday auctioned $41 billion of five-year notes, with a 2% coupon, a 2.065% high yield, a price of 99.692719. The bid-to-cover ratio was 2.38. Tenders at the high yield were allotted 64.27%. All competitive tenders at lower yields were accepted in full. The median yield was 2.030%. The low yield was 1.980%.
Treasury also auctioned $40 billion of two-year notes with a 2 1/8% coupon at a 2.125% yield, a price of par. The bid-to-cover ratio was 2.75. Tenders at the high yield were allotted 45.29%. The median yield was 2.100%. The low yield was 2.020%.
Tender rates for the Treasury's latest 91-day and 183-day discount bills were lower as the $36 billion of three-months incurred a 2.310% high rate, down from 2.335% the prior week, and the $36 billion of six-months incurred a 2.320% high rate, off from 2.340% the week before. Coupon equivalents were 2.362% and 2.387%, respectively. The price for the 91s was 99.416083 and that for the 183s was 98.820667.
The median bid on the 91s was 2.295%. The low bid was 2.260%. Tenders at the high rate were allotted 89.95%. The bid-to-cover ratio was 3.15. The median bid for the 183s was 2.290%. The low bid was 2.260%. Tenders at the high rate were allotted 41.95%. The bid-to-cover ratio was 2.91.
Treasury to sell 4- and 8-week bills
The Treasury Department said it will sell $40 billion of four-week discount bills Thursday. There are currently $34.999 billion of four-week bills outstanding.
Treasury also said it will sell $35 billion of eight-week bills Thursday.
Gary E. 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 Ziad Saba at 212-803-6079 for more information.