Strong demand brings richer muni/Treasury ratio, should absorb week's new paper

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The municipal market is prepping for$5.84 billion of new bonds, including the biggest deal of the year thus far.

As the market awaits the new paper to hit the street, Patrick Luby, Senior Municipal Strategist at CreditSights, said quiet trading last week may be more of an indicator of a lack of desirable bonds, rather than a lack of demand.

“Municipal demand has been strong and allowed munis to out-perform U.S. Treasuries last week,” Luby said. “Benchmark muni yields moved slightly higher last week, but by less than Treasuries did, and as a result, the muni/Treasury yield ratios got even richer than they were before.”

Will demand be strong enough to absorb $2.3 billion in new California G.O. bonds? The BVAL California benchmark yield curve moved 1 basis point wider last week, but Luby believes that a new offering of this size from one of the world's largest economies will attract even offshore investors.

“Demand will be bolstered at least in part by some investors wanting to get ahead of the upcoming redemptions, with $11 billion scheduled to roll off in the months of March, April and May, followed by $5.4 billion in June, $4.9 billion in July and $9.7 billion in August,” he said.

Luby said that new-issue supply is 14% higher than the prior week, but the bulk of supply will be from those two issuers. Other than California and New York City, there are only six other issues of $100 million or more expected.

Narrow trading range, strong demand
Low supply and active fund flows persist in the municipal market, as tight trading conditions stem from reduced state and local tax deductions as a result of tax reform and growing multi-asset allocations, according to Kimberly Olsan, Senior Vice President at FTN Financial and Contributor to Court Street Group Research in a new report.

“The market’s narrow trading range seems indicative of a patient investor base waiting for when (if) the calendar will grow,” Olsan wrote in the March 4 report.

Upcoming supply is heavily tilted toward California and New York, where an aggregate $3 billion is due for pricing this week, she noted. “Within New York, the scale of Metropolitan Transportation Authority (MTA) issuance makes it one of the most-actively traded names in the market and a vital regional transportation provider,” she wrote. Volume is currently 21% ahead of 2017’s pace -- which suffered from the late surge -- yet lags early 2017’s volume by 17%, according to Olsan.

“Should any supply materialize in the 10-year range, the value in extension equates to about 40 basis points and increases taxable-equivalent yields to near 3.50%,” Olsan said. Fund flows, she said, are having a larger effect on technical performance the longer supply stays below $8 billion per week, she noted. “Between ICI and Lipper, weekly average inflows are $1.4 billion in 2019, or 25% of new-issue supply totals,” she said.

According to Olsan, active reinvestment cycles are adding to the demand component and setting up what may be a sustained lower-yield range. “The 10-year AAA BVAL 2.12% yield is just 13 basis points away from its early-January 2018 low, while relative value has remained steady between 80%-82%/10-year UST,” she wrote.

Market technicals
The impact of limited supply in February -- during which volume was expected to reach $25 billion -- resulted in a stagnant yield curve and tighter credit spreads, Olsan said.

“Most major spot levels essentially treaded water, following a powerful rally that has taken yields lower by 40-60 basis points since November,” she noted.

These conditions indicate fairly uniform returns along the entire curve, with major spot points up about 0.35%, according to the Bloomberg Barclays Index data, she said.

Both short and long maturities will likely return an excess 15 to 20 basis points against their 5-year February averages, she wrote, driven by “what has been unusually quiet new-issue conditions.

“Much of the resistance to testing a lower range is driven by already-low absolute yield levels and rich ratios out to the intermediate range,” she wrote. As credit curves continue to collapse, AA-rated revenue credits are trading near AAA GOs, Olsan said. “February’s yield decline commoditized short-dated maturities, where the 1- to 5-year slope was set to close out at a mere 10 basis point slope.”

The credit spread history in 10-year maturities since November 2018 indicate all major revenue sectors are currently trading below their three-month highs.

Most actively traded Texas and New York general obligation bonds and the double-A rated revenue sector are at their lows, where the state of Texas GOs are trading at just four basis points higher than the triple-A GO scale.

In addition, single-A and triple-B revenue bonds are tighter by 12 basis points from earlier highs, but triple-B credits have widened 15 basis points versus double-A bonds from prior low spreads, according to Olsan.

Home Sweet Home
Among the attractive sectors, so far in 2019, the housing sector is showing strong demand on greater issuance totals, according to Olsan.

The sector has benefited from a 300% gain in volume to $2.3 billion so far in 2019 compared with $756 million last year after a slow start for all sectors in 2018, she noted. “Returns belie the gain in volume -- the January/February period saw the sector lose 1.24% last year, but current gains sit at 0.64%,” Olsan added. She also noted that indicative 20-year double-A housing/triple-A credit spreads have remained steady from the same time last year, at an approximate 79 basis-point spread. The sector is performing well with a spike in supply, perhaps due to its pure spread to Triple-As, generally high-quality across most issuers, and after-tax yields that approach 6% for 20-year maturities, she said.

BofA Securities: Blue tide lifts munis
According to a report released by Bank of America Securities, Iin February, munis led Government and High-Grade corporate returns. The research team at BofA expects that to continue. The $10,000 cap on state and local tax deductions (SALT) raised the effective tax rate in many large, blue states, and investors are realizing it as they face their tax bills this year.

“Blue state munis have performed better as SALT tax cap raises effective tax rates,” the report said.

Another interesting takeaway from the report, is that the Vice President promises a "historic" infrastructure bill.

“Vice President Pence promised a gathering of governors that a `historic' infrastructure bill will be signed into law this year,” the report said. “We are not particularly optimistic that an infrastructure bill will be enacted this year though we may see a "change in the winds" after a planned U.S. House Ways and Means hearing on infrastructure expected in March.

Primary market
This week will bring the biggest deal of the year, when California comes with $2.3 billion of general obligation bonds. (Aa3/AA-/AA-). The offering is $2.05 billion of various purpose refunding GOs and $250 million of various purpose new-money GOs. The deal is expected to price on Wednesday, following a one-day retail order period.

The prior biggest deal of the year, was also from the Golden State, when the Airport Commission of the City and County of San Francisco sold $1.76 billion back on Jan. 11.

Also on tap this week is a $914.245 million GO offering from New York City (Aa1/AA/AA). The sale comes at a good time, fresh of Friday’s upgrade by Moody's Investors Service to Aa1 from Aa2. Siebert Cisneros Shank is set to price the city’s Fiscal 2019 Series E and F tax-exempt bonds on Wednesday after a two-day retail order period.

The city will competitively sell $71.89 million of taxable Fiscal 2019 Series F, Subseries F-2 GOs, also on Wednesday.

In the competitive market, Boston (Aaa/AAA/NR) is selling $145.13 million of GOs on Tuesday.

Baltimore County, Md., will be selling $246 million of consolidated public improvement bond anticipation notes on Tuesday. (MIG-1/SP-1-plus/F1-plus).

Monday’s bond sale

New York City – Day one of ROP

Secondary market
Municipal bonds were mixed Monday, according to the MBIS benchmark scale, with muni yields falling as much as one basis point in the one- to seven-year and 11-year- to 15-year maturities. Yields rose as much as one basis in the nine- to 10-year and 16- to 30-year maturities. The remaining maturity was flat.

High-grade munis were mostly weaker, with yields rising no more than one basis point in the seven- to 30-year maturities. Yields were lower by one basis point in the one- to five-year maturities. The lone remaining maturity was unchanged.

Investment-grade municipals were steady on Refinitiv Municipal Market Data’s AAA benchmark scale, which showed the yield on both the 10-year and 30-year muni unchanged.

On Monday, the 10-year muni-to-Treasury ratio was calculated at 78.3% while the 30-year muni-to-Treasury ratio stood at 97.2%, according to MMD.

The ratios have gotten richer of late, as the average 10-year ratio from March 20, 2018 until today, is 84.0%

Prior week's actively traded issues
Revenue bonds made up of 55.03% of total new issuance in the week ended March 1, down from 55.40% in the prior week, according to IHS Markit. General obligation bonds made up 39.30%, up from 38.85%, while taxable bonds accounted for 5.67%, down from 5.75%.

Some of the most actively traded munis by type in the week ended March 1 were from Puerto Rico issuers.

In the GO bond sector, the Puerto Rico Commonwealth 8s of 2035 traded 5 times. In the revenue bond sector, the COFINA 5s of 2058 traded 104 times. In the taxable bond sector, the COFINA 5s of 2058 traded 31 times.

Previous session's activity
The Municipal Securities Rulemaking Board reported 35,288 trades on Friday on volume of $10.421 billion.

California, Texas and New York were the municipalities with the most trades, with the Golden State taking 16.531% of the market, the Lone Star State taking 12.046% and the Empire State taking 8.392%.

Treasury auctions discount rate bills
Tender rates for the Treasury Department's latest 91-day and 182-day discount bills were higher, as the $48 billion of three-months incurred a 2.410% high rate, up from 2.405% the prior week, and the $39 billion of six-months incurred a 2.460% high rate, up from 2.455% the week before.

Coupon equivalents were 2.465% and 2.532%, respectively. The price for the 91s was 99.390806 and that for the 182s was 98.756333.

The median bid on the 91s was 2.380%. The low bid was 2.350%.

Tenders at the high rate were allotted 57.05%. The bid-to-cover ratio was 2.76.

The median bid for the 182s was 2.440%. The low bid was 2.400%.

Tenders at the high rate were allotted 0.90%. The bid-to-cover ratio was 3.03.

Treasury to offer $30B 42-day cash management bills

The Treasury Department said it will auction $30 billion 42-day cash management bills on March 5.

Noncompetitive bids are due by 11 a.m., Eastern time. Competitive bids are due by 11:30 a.m., Eastern time.

The bills have an issue date of March 7 and are due April 18.

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.

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