High-Yield in a Higher-Rate Environment

While high-yield out performed municipal investment grades in 2024, macroeconomic and policy uncertainty, market volatility and higher yields have put more pressure on most sectors in the muni space, high-yield included. What is the outlook for high-yield for the rest of 2025 and beyond as new policy shifts play out and economic pressures grow? What sectors or areas of high-yield are investors monitoring? Where are there opportunities?

Transcription:

Lynne Funk (00:14):

Hello everyone, and welcome back if you're joining us for our second panel today at the Bond Buyer Virtual Buy-Side Summit. I'm Lynne Funk, I am Senior Director of Strategy and Content and Live Media with the Bond Buyer. I am very excited to welcome our panelists in this high yield panel. Certainly a great time to be discussing the sector. First, just a few housekeeping rules. Please do ask questions throughout the session in the chat function. If we can't get to your question, we'll try to get it back to you at the end. I'd also like to let you know if you are seeking CPE credit, you must remain on for the full duration of each session and respond to all the polling questions. You'll also need to complete a CPE plus evaluation form by Tuesday, August 5th. With that said, I'd also welcome anyone to certainly ask questions throughout the session, and we will get started here. I am going to introduce this wonderful panel. Sadly, no bios for them, I've told them anyway. We are so delighted to welcome Dan Close with Nuveen, Ozi Sander from Wells Fargo, Chris Brigati from SWBC, and Dora Lee from Belle Haven. They have a really wonderful discussion coming up here. Chris Brigati is going to be our moderator, and with that, Chris, I will hand it off to you.

Christopher Brigati (01:47):

Thank you, Lynne. I'm looking forward to this. I think we've got a great panel, and we're going to cover a wide variety of topics surrounding the municipal high yield space. The panel is well-versed, and we'll cover a lot of this quite well. I guess we'll kick it off to Dora first, and ask, go around the table with everybody. Just to kick us off, Dora, can you provide some big picture overview of the high yield municipal space thus far in 2025?

Dora Lee (02:14):

Yeah, so it's been quite a ride this year and quite a ride the last couple of years. We had very little supply and increasing demand in the high yield space, and now in 2025, we kind of have the opposite. We have had some increase in high yield supply, and broadly supply overall in the muni market, and with the outflows in the high yield space, we have that decrease in supply, which is a little ironic, I could say. But so far, it's been interesting.

Christopher Brigati (02:51):

Great. Excellent. Dan, any big picture things you can point to?

Daniel Close (02:55):

Yeah, and first, thank you, Lynne, for having me, and Chris, thank you again for hosting. I think the biggest story in high yield has really been just how different it was since last year. By my numbers, high yield last year outperformed by almost 5%. This year, high yield's underperforming by about 130 basis points. To Dora's point, the last couple of weeks have been particularly difficult for the high yield market. Seeing the supply, the technicals, the flows, I think are all contributing to it. Last year was a very bifurcated year with high yield just meaningfully outperforming—a 500 basis point outperformance, you really can't point to many years where you have that much of an outperformance. I think some of what we're seeing this year is a little bit of a give back, underperforming through last night by about 130 basis points. So, obviously looking forward to what the balance of the year brings, and certainly what the technicals might have in store for us.

Christopher Brigati (04:00):

Excellent. Ozi, any thoughts here?

Ozi Sander (04:02):

Yeah, I echo Dan's comments as well. Chris, thanks for having us. Lynn, thanks for having us. I did agree to be on this panel when I thought there were cocktails afterwards, so now that there's virtual and there's no cocktails, I think we're going to have to talk about that. But I think Dan's points about the high yield underperformance is a real one, and we're seeing that in the secondary every single day. To Dora's point on the primary market as well, we have seen supply tick up. Obviously, you've seen some Triple-B supply up with large real infrastructure, toll projects, but what I am seeing over the past year or so is a much more selective buyer base when it comes to the primary market. So the deals that are getting through, I think are much tighter from a security package. You're seeing more covenant-heavy type of transactions, unlike what we've seen over the past five to six years.

(04:50):

I really wouldn't have expected high yield to underperform going into a rate-cutting cycle, but here we are. If you look at what we've had to deal with over the past six to seven months in the high yield market, we've had seven or eight different mini credit crises. We obviously had April with the spending bill, we've had two account liquidations, right? We've had two portfolio trades, which obviously affected more the high grade side of the business, but when you're seeing high-quality discount names traded at 5.75% to 5.50%, that's where benchmark Triple-B non-rated debt was trading just six to seven months ago. So you're seeing a real dislocation in the market. I think what the spending bill in April forced the market to really go through is a come-to-Jesus moment when it comes to sector selection, right? Healthcare is one of the largest sectors I focus on a daily basis, and now having real conversations with accounts on payer mixes, on structure of the bonds.

(05:47):

So high yield's kind of taken it from two sides of the equation, right? We've taken it from a credit standpoint, but then we've also taken it from a duration standpoint. Some of the high yield bonds that were structured over the past year or so—I guess we can even say over the past two years—tended to be high coupon structures. That's just the nature of the high yield market. But we've seen massive duration extensions with premium bonds pricing to 10-year calls, going to discounts. So we've seen funds that have eight to nine year durations going into this credit cycle have extended. I think the long end of the market has gotten cheaper based on supply, but then we've also seen duration and credit issues as well, specifically on idiosyncratic issues over the past couple months. So it's been an interesting six to seven months filled with price discovery, which I think some would say is a good thing or a bad thing, but we are starting to be more selective as to what is accessing the capital markets, which I think is a massive positive going forward.

Daniel Close (06:48):

Chris, I'll jump back in uninvited at this point and share Ozi's theme about certainly the drinks not being around, but as well, I think the duration underperformance. If you go to our call center, talk to folks that are on the front lines with FAs, I think the assumption is a lot of the underperformance in the high-yield space has to do with credit specifics, that you have one idiosyncratic credit event that's causing the underperformance. But if you look really even in the last three weeks, when we've had this notable underperformance, it's really more duration based. The automatic assumption, especially from retail investors, is if you're down 3%, 4%, 5% on the year in high yield, it has to be a credit event. We're just not seeing—I know we're going to get it deeper in this panel—we're just not seeing those idiosyncratic credit events. It's just more of a high yield tends to live further out on the curve, and further out on the curve has just dramatically underperformed so far this year.

Ozi Sander (07:46):

That's a great point as well. I think if you actually look at what's happened over the past in the past 20 years in the municipal world, I would argue there's never been one single credit event that's caused outflows, right? You could talk about Puerto Rico—didn't really cause outflows. You can talk about Meredith Whitney, when every single muni was going to default—never caused outflows, right? It's always rates, rates, rates, and we're never going to perform when we have the rate volatility that we've seen. It's never credit. If you want to accomplish the corporate credit, we're cheaper relative to corporate credit than we've ever been—oh, sorry, over the past 10 years. We're significantly cheaper than we were during COVID, during COVID, and these are hard assets, not to jump back in.

Dora Lee (08:30):

I think it goes back to your point about investors being a lot more selective this year and really tightening up on their covenant packages and the strengths and the stronger credits that are coming to market and the demands that investors are imposing on issuers to make sure that the credit itself is on sounder footing. So again, it's not really a credit story, it's more a rate story, but yeah, I guess when people are worried about credit, it keeps me employed, so we'll keep that going.

Christopher Brigati (09:08):

Well, I think it's interesting. I think you brought up some really interesting points there, especially the duration factor, which does get lost in the high yield space specifically. People tend to lose sight of that overall in the municipal market, but specifically when we have these type of events as we've had over the past year with rising rates and the different factors we've been dealing with, it does affect the market in different ways, and I think it's great to point out, especially for retail investors to understand. With that being said, Lynn, do we want to kick off with the first CPE credit question?

Lynne Funk (09:39):

Sure thing, and actually we'll ask the audience their thoughts here. So high yield munis outperformed, as Dan mentioned, high grades by significant margins in '24. While the muni asset class has underperformed other fixed income markets this year, the high yield sector is seeing larger losses so far. Will high yield see a recovery to close out '25? The answers are: A, the sector will end in the black; B, the sector will likely see losses this year; C, I'm not so sure. Let's give the folks a couple seconds here to reply. The high yield losses are from Bloomberg indices: 2% as of yesterday, year-to-date, while investment grade is 0.8% year-to-date. I'm going to close it out and turn it back to you in a moment here, Chris. And the answers are: A, the sector will end in the black, 22%. B, the sector will likely see losses this year, 50%. C, I'm not sure, 29%. Good answers. Back to you, Chris.

Christopher Brigati (11:00):

Thank you. Anybody have any comments to those percentages?

Daniel Close (11:05):

I think it makes sense. Given we're 2% down, it's not probably a—it's like doing your end game parlay and your team's already down a bit as you're making your bet—but I thought it would be a little bit higher. That's probably the eternal optimist in me in the high yield side and the muni side, just given how dislocated we are versus other fixed income. But I don't know, it's necessarily a surprise, given we're starting to dig out of negative 2% from an absolute basis.

Ozi Sander (11:37):

I'm a little bit surprised that a third have no opinion or aren't sure. I think that's what surprises me a little bit.

Dora Lee (11:45):

I think I'll be in that third camp that makes no sense. I think if anything that has, from the pandemic on, it's always expect the unexpected. So I know it's a 50/50 chance. One day you think one thing, and then you turn on the news, and something completely unexpected has happened.

Daniel Close (12:06):

Chris, what do you think?

Christopher Brigati (12:08):

I'm kind of in the camp. I'm a little underwhelmed by the number that didn't expect a bigger loss this year. I thought that would be a little higher, but other than that, I think people are also reluctant to have much of an opinion sometimes. So that boosts up some of that unsure number a little bit. That being said, Dora gave us a good segue with the unexpected for the next question. This year we've seen a lot of unexpected events—everything from Trump tariffs to OBBA to liquidity in the space, the dollar really underperforming overall. A lot of things have really impacted the economy and overall markets. What unexpected events might you have seen that have impacted the high yield space, and what have those impacts become, and how have they developed? Dora, first, I guess?

Dora Lee (13:00):

Yeah, I think the biggest unexpected event was that the muni tax exemption was so discussed going into the OBBA, and then once it passed, it was kind of a whole big nothing burger. The tax exemption was largely preserved. So that was the big hurry up and wait kind of ordeal. We think something's going to happen, and we spent a lot of time talking with clients about what that could mean, only to wake up one day and it was like, "Actually, you could just forget everything. Everything's going back to normal." Again, the tariffs, I think we're still kind of in a wait-and-see moment of how that is going to trickle down to the overall economy and how that's going to be digested throughout.

Christopher Brigati (13:56):

Great. Dan, any ideas?

Daniel Close (13:59):

I could agree with Dora here. It seemed like up until July 4th, most of our time and effort here on the desk were talking about the muni market, the desperate search for pays, knowing that the exemption was costing $40 billion, and that every nickel in the couch cushion is going to be scrounged for to roll the TCJA. Then it rolled, and there really wasn't the bounce back. I think heading into this, every conservative had all the intellectual cover they needed with the Cato Institute and with Heritage and others going in and saying, "Municipals really are inefficient. They're only favoring the wealthy," which I think you could easily impeach those arguments. But then to have all that, and I think it's really a credit to the muni industry being able to demonstrate that the exemption is very local, it's funding local infrastructure. I think for our part, we were really encouraging local issuers to talk to their congresspeople and say, "Hey, if we had to build this high school now, if we didn't have the exemption, it wouldn't be $60 million; it'd be $90 million."

(15:11):

I think that grassroots efforts really helped. I think it was our hope and understanding—though hope is not an investment strategy—that with the tax code clarified, not even private activity bonds coming out with any blemish, that we'd see a little bit more of a rally. I've been surprised this year with just how in April every other asset class got hit in the fixed income side, and the fact that our asset class is underperforming the Barclays Agg by 450 basis points without really much of a whiff of a credit issue is, I think, really surprising. I think that's been the biggest surprise: not only that the passage of the OBBA didn't really create any systemic inflows, but as well that every fixed income asset class got hit hard in April. The Barclays Agg is up nearly 4% on—excuse me—3% on a year-to-date basis—excuse me—4% on a year-to-date basis,

(16:13):

and munis are down, and high yield is especially down. The fact that we're underperforming this much every other fixed income asset class again without really any hits to our fundamentals, I think it's been a huge surprise for me and for the entire market. Now we have all this data which shows, gosh, when you're underperforming this much, how quickly it takes to get back to performance, get back to where the Agg is. But the slowness of that recovery has just been, I think, really difficult. I think it's just been a surprise to see how long we've lingered in this underperformance for munis and especially high-yield munis since that first week of April.

Christopher Brigati (16:54):

Great. Ozi,

Ozi Sander (16:55):

I'm not going to steal Dora and Dan's thoughts, but I think what surprised me the most—I'll go in a different route—I think what surprised me the most is every single strategist was telling us, "Okay, spending bill is going to be negative for munis." To Dora's point, it wasn't, right? But issuers were concerned, and I think a lot of the supply was pulled forward. We're still about in—what is it?—it's almost August. We're still averaging $15 billion to $16 billion a week, right? So was the supply really pulled forward, or that was just the normal supply, right? Are we going to hit $550 billion or $600 billion in supply this year? I think that's the bigger question. So I think my surprise of the year was that the narrative that the supply was pulled forward wasn't really accurate. An additional surprise I had was when we did blow out in April, and every single asset class to Dan's point, including equities, were taking on the chin, we still had a lot of crossover buyers jump into the market, even at 95% to 96% ratios in April.

(17:55):

I was surprised they jumped in the market as aggressively as they did, specifically given the corporate tax uncertainty, right? If you're buying an asset class at 96% based off of 25% corporate tax rate, there were obviously discussions about corporate tax rates going to 15%. I was surprised they jumped into the market given the tax code uncertainty, but I was pleasantly surprised at what they bought. They bought clean fives, they bought clean five and a quarters, and they even bought large discounts. We're starting to see that now. So I think supply being pulled forward surprised me. Corporate crossover buyers in April surprised me to the extent that they came in, and I think the delay they've had over the past couple of weeks to buy the asset class—we've gone from 90% to 96% ratios—also surprised me.

Christopher Brigati (18:43):

Great. One of the things that I talked about at the beginning of the year was my forecast for the overall supply picture, and I was at a $525 billion to $550 billion range. Right now, I've kind of revamped it to say the higher side, I expect $550 billion to be met. We could see even higher based on what's happening for the second half of this year thus far, because I do not see the supply picture slowing down overall. I do think that that will continue to weigh on ratios, continue to get crossover buyers interested in the market and engaged. Ultimately, that's going to kind of create a floor. Back in my days of running business at Morgan Stanley, seeing retail really engaged, I was always thoughtful that when retail picks up their head, you know, have some real buying to happen, and I think we're really close to seeing some of that support coming in on a macro basis.

Daniel Close (19:33):

Couldn't agree more.

Ozi Sander (19:35):

I do 100% agree with you, Chris. I think the additional incremental buyer is what the market needs, especially if flows on the mutual fund side are going to kind of be lackadaisical. Obviously, we've seen ETF growth in the market. I think ETF assets are $140 billion. They've grown massively over the past five years. My big worry for mutual fund flows is if we continue to see fives at a discount, clean five to 5.25% clean fives to 5.20%, I think the mutual fund complexes aren't just competing against ETFs or SMAs down the curve, but they're also competing against individual muni bonds, specifically muni bond selection, especially if fund distribution yields are a little bit lower than what individual bonds are yielding, right? I think that's an additional competition for some mutual funds, which I think could slow the recovery down a little bit. That being said, we've still seen $4 billion of inflows into the high yield asset class so far year to date. With the exception of that one week in April where we saw $3.5 billion of outflows, we've actually done fine, but we haven't necessarily broke even from the $20 billion we saw a couple of years ago.

Daniel Close (20:45):

I think that worries me too. If you right now have clean 5% coupon, 30-year, 10-year no-call structures at a discount, and it's not bringing in flows now, I'm not sure what's going to do it. You keep on ticking through as far as, well, if this improves and we get the OBBA passed and the exemption comes out, we're going to be fine. Or if we don't have any issues with respect to tax collections, we're going to be fine. We're at this inflection point where long fives at a discount has in the past at least been the all-clear signal, and we just haven't seen the flows. The biggest determinant in our estimation of total returns, given the retail component, is that inflow side. When you have $150 billion out in '22, another $25 billion out in '23 of 40 ACT funds, and year-to-date you're staring down $10 billion, $12 billion, $14 billion in inflows, it's tough to go in and to really make up performance. It's even tougher to see with this inflection point not really creating any urgency to it, what changes it. Of course, we naturally move on to the next thing: "All right, what happens if cash at your broker-dealer gets below 4%? You see two rate cuts and another two in '26." Does that really move people off the sidelines? I hope so, because every other straw we've been grasping at as far as what gets inflows going has so far proven to be a mirage.

Ozi Sander (22:19):

I mean, the bull case obviously, to Dan's point, is the Fed cut, which I think we're closer to a cut than a hike, depending on the day, who the heck knows? So let's say we see a cut. Retail is three to six months in the rear view mirror. They pump in the money that's sitting on money market funds, which by any estimate is $7 trillion to $8 trillion. It's not going to take much to move this market, right? So I think that's obviously the bull case. But I think to Chris's point earlier about his supply estimate, that's I think the big worry in the market. But I mean, you look at the amount of deals that have gotten done so far year to date, there clearly is—there's clearly demand, right? There was a $3.5 billion deal that just got done that was one to three times over on four large maturities out long. That deal's not getting done in April.

Christopher Brigati (23:09):

Good point. Good point. Lynn, turning it back to you. Do you want to throw another question out there for the audience?

Lynne Funk (23:16):

Hi, actually it's kind of apropos. We're going to ask our panel—sorry, our audience—about supply. So here we go. The question is, "While overall muni issuance has been on a record pace, high yield totals have not kept up. Given policy shifts that are in Washington that are anticipated to put some pressure on issuer credit, high yield issuance will: A, pick up in the rest of 2025 and beyond; B, as credit pressures rise on certain sectors due to policy shifts in Washington, growth will occur primarily in those specific sectors; C, high yield issuance will continue to lag."

(24:01):

I'll give it a couple seconds here. I just actually saw this morning—I saw on the previous panel I mentioned this too—that LSEG data shows $333 billion total issuance through today, which is a 16% increase over '24 levels. That's all issuance, not high yield, clearly. All right, I'm going to give another second here, and then I'll give you all the answers. All right, I'm going to close up this poll, and the answers are: A, 22% believe that high yield issuance will pick up in the rest of '25. B, 30% say, as credit pressures rise on certain sectors due to policy shifts in Washington, growth will occur primarily in those specific sectors. C, 48% say it will continue to lag. Back to you, Chris.

Christopher Brigati (25:04):

Great, thank you. I think that 48% lag, I'm not completely surprised by. Maybe there's a little bit of a rate call embedded within that answer, too, in terms of people not expecting as much of a rate cut this year, and that could lead to a little bit of a lagging of supply. Any thoughts from the panel?

Dora Lee (25:26):

I do think supply is going to specifically for the high yield will continue to lag. Just, you're seeing back to earlier in the panel, you're seeing tighter covenant packages, investors are demanding more, and also you're just looking at so much more volatility, which is not a great environment for high yield projects to begin with. So given those two dynamics, I think high yield supply will continue to lag. Not to cover my bases, but in the areas that have any hope of increasing supply are those pressures—are the sectors where you see a lot of pressure where issuers have no choice but to come to market to cover operating deficits or replenish cash and try to dictate their balance sheet?

Daniel Close (26:25):

Yeah, Chris, I'd agree with Dora here. The one thing we haven't seen come back to our market, at least in mass, are these project finance deals that have the unproven technology, perhaps, or don't have the equity in them if it doesn't work out or might not have the offtake contracts, for instance, put together. But I think on the supply side, you also have to look what's driven supply in the past, and you're kind of out of room. There might be a couple more outliers, but there's not the big 1998 type tobacco deals that are going to get refinanced again. I think those have largely come and gone. The Puerto Rico that was a profligate borrower, we don't see some of these big benchmark high yield deals coming. One thing that we point out a lot to our clients is just how much the market has flipped in the last 10 years.

(27:24):

In 2014, 75% of deals in the high yield space were rated, and now that number is down to about 30%. So it's absolutely flipped where 70% of the market's non-rated, 30% is rated. You're seeing a lot more deals, 10, 12, 14 deals in a given week, but they tend to be a smaller community development district, a smaller charter school, not the large blockbuster deals. I mean, Ozi's referring to it, it's kind of, sort of, maybe high yield, but seeing the $3.5 billion tollway deal this week get done, there just have not been these large, very large $2 billion, $3 billion CUSIP, like a Buckeye five to 55, $3 billion CUSIP that is coming to market. With that lack of larger, big deals coming, and I think with a little bit more market discipline on project finance deals, I find it hard to think that we're going to see this deluge of supply coming. I can completely be wrong on that, but I think the greater trend we're going to continue to see is a lot more number of deals, but more likely than not that those deals coming on are smaller.

Ozi Sander (28:50):

Yeah, I think both Dan and Dora made good points. I think if you look at the supply we've seen on the high yield side, it's rated high quality and aims at high yield. Some of these IG-rated project deals—and I'm not saying science experiment projects when I say project deals, I'm talking about terminal deals, toll road deals—these are coming at high yields. These are coming where 150 basis points wider than they would come last year, right? Credit spreads are wider in some sectors as well, and obviously absolute yields are higher. I've been very proud of the market over the past six months for saying no to certain deals, right? We are not a science experiment type of market anymore. The cost of cap—I think three years ago we were seeing deals because every single other asset class said no, bank financing said no, corporate said no, leveraged loans said no.

(29:43):

Every asset class said no. I think now we're finally starting to move the pendulum in the favor of the investors and understand what we're asking for and just saying no. There are some deals we've looked at: if you don't have double-digit yields, it's a non-starter. Forget about just an offtake agreement. How about an offtake agreement for the life of the bonds plus some, right? I think we're getting much more savvier when it comes to the credit side of the business. I think there's been a lot of expensive lessons learned, and I think the market is not going to repeat those mistakes, at least until the Fed cuts three or four times. Then I think we'll probably try that again. But I think we have a little bit of leeway. The one thing I would be a little bit worried about are some of these private transactions.

(30:25):

I think there's a shadow amount of supply on the high yield side that's not getting captured within that supply number. I think I'm seeing a lot of that on the higher ed side, right? Higher education institutions don't want to open up their balance sheets, their operational side of the business, their secret sauce, and instead they're doing direct private placements with the accounts, which obviously are a little bit less liquid, but they're able to have speed and efficiency when it comes to financing. But I think to Dora's point about issuers accessing the capital markets to fund operations, I personally think that's over, at least for now. I think negatively operating and doing a deal to inject cash onto your balance sheet I think is something we're not going to do anymore, at least in the short term.

Christopher Brigati (31:14):

That's a good point. I think it introduces a level of fiscal responsibility that is obviously needed across all markets, but to see it in the base market of the safety of municipal, even if it's high yield, I think that's an important and relevant discussion point. We did get a question that's interesting, and it kind of gets to what we were talking about a little bit earlier on our first question, so I want to throw it out. I think, Dan, you kind of brought up some of this. The question is, "Do you believe all or nearly all of the risk of callable bonds sliding out to maturity has already been realized, and the muni market is now as long in duration as it will be so long as rates don't move higher?" So basically, do we think that rates are going to peak out here based on duration extension of the high yield market?

Daniel Close (32:02):

I can jump on that one. I think we've seen as much extension as we're going to see, which I think is another way of saying that we're probably at peak rates right now in the muni market. I think what we consistently point out is right now with the muni yield curve, we're more than two times steeper from twos to thirties than the government yield curve is, and we don't have the kink from the 20 to 30 year part. You've got this radical notion that if you lend your local water and sewer authority money for a longer period of time, you're going to get paid more interest, and that's not the case in every part of the fixed income marketplace. So I think it was either Ozi or Dora that was going and making mention of the extension that we're seeing in high yield and writ large for the entire muni market.

(32:54):

I think that extension is probably run its course. It's not to say we don't have perhaps a little bit more to go or we won't backslide, but I think the reshaping of the muni yield curve—I don't know if it was Chris, your second question about surprises where we kind of went from the Nike swoosh to kind of wave at the spoon saucer, and now we just have a regular old upwardly sloping muni yield curve. I think with that, and I think with some really painful adjustments so far this year, I think you've seen a majority of any extension that you're going to see from the optionality in structures. I think right now, especially with again, a high yield deal coming yesterday with solid six-handle coupons that are coming at a premium, I think if there is any extension, especially going from five to five and a quarters and in the high yield space, even touching six-handle coupons, I think a lot of that extension has probably already happened, and I don't foresee a much more meaningful extension in duration.

Ozi Sander (34:03):

I agree with Dan. Even looking at 10 to 15 year five with slightly shorter calls, those are priced to 99 and three quarters. So I'd say a majority of the yield curve, especially down the curve, is shorter calls are at a discount. So I think we have to be in a much more higher yielding environment for the asset bond to extend from a duration standpoint even more.

Christopher Brigati (34:26):

Great. Makes sense. Let's get back to our round of questions we were talking about before then. I know on our desk at SWBC, when we're talking, the tariff story has come up repeatedly daily. It's in every chat we're in, it's in every conversation we have. Every morning meeting starts off with something we're talking about the prior tweets from the previous night. What impacts do we think that the tariff situation has had upon the high yield municipal market? How have the threats realized or unrealized really impacted high yield municipals?

Ozi Sander (35:03):

I can jump in on that one. I think from a tariff standpoint, I think what we've seen, it's been pretty mitigated. We haven't seen massive negative price action based on the tariff news. I think if you look at the most exposed sectors, you could say airports and seaports as well. From an import-export standpoint, cargo revenues there seems and passenger revenue seems to be pretty stable as well. We're actually growing. I think the part of the market that we haven't seen effects on tariffs yet, from tariffs yet, which I think we could, are probably some of these larger construction type of projects. I think we'll probably end up seeing that in the next couple quarters of disclosure, if they have good disclosure. But I think it's really hard to budget a big construction project when steel prices are up or obviously yesterday were down, they're exempt, but other input prices which are up 20 to 30% from where you budgeted. So I personally haven't seen it yet. I think the market's nervous, but I think the market's also cautiously optimistic that we haven't seen negative price action yet from any of the tariff implications.

Christopher Brigati (36:10):

Great. Dora, any thoughts?

Dora Lee (36:12):

Yeah, I think it kind of goes back to high yield supply and the lack of project finance deals with the big toll road as an exception. But I think those are probably where we're going to see tariff prices hit the most acutely. But the tariffs are on again, off again. So until we see a true tariff rate that will be kind of stable for longer periods of time, I don't know, it is hard to gauge what the ultimate ramifications are. So far, I think everyone who can delay buying those inputs, input goods, are trying to manage that. I think we're probably going to see the ultimate effects in the next several quarters and going into next year.

Christopher Brigati (37:15):

Anything to add on that one, Dan?

Daniel Close (37:17):

I think the other panelists covered it well. Fundamentally, we've got an asset class that is not a consumer cyclical where you're producing something. I'm in the city of Chicago, which some would argue certainly a high yield issuer. It's not producing anything that's shipped overseas; it's really not importing anything. I think Ozi hit on it that with aluminum, steel, perhaps having higher input costs, high yield issuer, high yield-light projects like airports are certainly going to see higher costs to develop. I think it kind of gets back, Chris, to your question on are we going to see more issuance? I think that with the higher labor costs, and even if inflation has kind of petered out a bit, we're still at a higher point, 20% higher on basic input costs than we were five years ago. So I think you have that impact of just more issuance because your big ticket projects like your airport projects, like Terminal One right now going into New York, is going to go in and just be elevated. So I think it's just more the issuance side and more for your larger high yield-light projects like toll roads and airports that are going to feel the most acute impacts.

Ozi Sander (38:40):

There could also be a positive implication for the asset class from tariffs. I haven't necessarily thought about this until more recently, but I think based on federal government data, the tariffs have raised anywhere between $125 billion to $150 billion. If that's a long-term positive on an annual basis, you could see maybe a shift of capital from the federal government back to the state, which I feel like under the big spending bill, we actually saw the opposite. So maybe that's a positive, but I'm also just an optimist.

Christopher Brigati (39:14):

High yield muni people are optimists just by definition, so that's all good. I think that brings up an interesting point, talking about airports specifically. We have seen resumption of air travel significantly. We've seen some record air travel at some of the bigger airports throughout the country, obviously bringing in revenue. Going through Newark and seeing what they've done, some of the terminals there, it's a much more inviting space, environment—not that you want to go there as the destination, but it's okay to be in while you're waiting or traveling to your next destination. I think that results in a little bit more spending, and we know how that helps to grow the revenues of those facilities, which ultimately can help if they do need to expand and might offset some of that 20% input cost to doing a new terminal or revamping something.

Ozi Sander (40:00):

Yeah, I think the common areas in some of these terminals—I know Dan's not aware of that—but there's common areas in terminals that are not part of a lounge, but where the people like myself hang out, they've actually made it pretty comfortable.

Daniel Close (40:14):

I don't have a response. And Chris, yeah, I certainly agree. I fly out of EWR, and it's actually a delightful experience, especially from the lounge.

Christopher Brigati (40:24):

There you go. Well said. Lynn, do we have another question we want to throw to the audience?

Lynne Funk (40:33):

Sure. So this is our final CPE question here, and it is about interest rates. Another crystal ball question. Okay, where do you see interest rates landing to close out 2025? A, lower than current levels; B, higher than current levels; C, too much uncertainty to see now. We'll let these come in. Okay. Interesting. I guess maybe if you guys delve into this, maybe I should have said we should have asked Treasury or muni, but I guess it's a little broad here, just interest rates. Okay, so I'm going to close it out, and the answers are: A, 66% say lower than current levels. B, 11% say higher. C, 23%, too much uncertainty to say now. All right, back to you, Chris. Thanks.

Christopher Brigati (41:50):

Thanks, Lynn. I think this is what's driving the narrative on trading desks and buy-side platforms and retail customers as well. Especially when I'm talking to some clients of SWBC, the question of where interest rates will be and why they will be there is of importance. We just saw a little bit of a glimpse of that yesterday with Chair Powell at the FOMC press conference and his narrative with regard to staying pat for the time being on short-term interest rates. So short-term interest rates obviously could go down, and it could not affect the longer end of the curve, but I think for the most part, people are assuming the longer end of the curve with this discussion point. So not really surprised to see that 66-ish percent lower than here right now. My personal thought is we have not seen quite the peak of the second half this year yet. I do expect a little bit of a rise in yields. We're heading into the October period, which is typically a tougher market environment for fixed income and municipals specifically. So I do think we could peak a little bit here, but by the end of the year, I expect this to be back around this 4.40% to 4.50% area where I really see it's kind of like the balance point for the market, and we've been hanging there for a long time. Any thoughts from the panel? Do you have any consideration here?

Dora Lee (43:05):

It was interesting that you bring up clients. I feel like we've been talking to clients about where interest rates will or will not be, and they probably think we're a broken record: "You might want to lock in your rates now if they might come down later. This is your time." But I think this time around, for specifically our clients, and I think going back to our market technical discussion earlier, going back to retail clients, I think they're kind of still sitting on the sidelines. They probably are not anticipating the drop in rates as much as we are.

Christopher Brigati (43:52):

Dan, any thoughts?

Daniel Close (43:53):

Yeah, I'd agree with Dora. We do sound like this broken record. We really do mean it that this time rates are going to come down. I think specifically to munis, though, once you get past that 10-year part of the curve, that call it 11 to 18-year part, it's just so steep, and you're getting paid for it that let's say you're wrong, and Chris, we agree, what if you have—it's not on a straight path—rates on the muni side back up for a bit. I still think you're certainly getting paid to extend. You don't have this really flat curve where extending out a bit is costing you. We had just written this up in our quarterly commentary about a month or so ago, how if you're buying a premium coupon in that 12, 13, 15-year part of the curve, and you've got that 10-year call provision, you're really not extending that much from a duration standpoint by going in and taking another year or two, but you're certainly getting paid for it. So not really answering your question directly as far as where absolute rates—we do think lower—but I would say that even if we're wrong and it takes longer to get to that lower point, you're certainly being compensated for that risk right now.

Christopher Brigati (45:09):

Ozi, do you have any thoughts?

Ozi Sander (45:11):

Yeah, I agree. I think just from a political standpoint, I think it's going to be hard for rates to go higher. So I think the next move is a substantial move lower in long-term rates.

Christopher Brigati (45:24):

Great. I think when we look at some of the things that we're talking about in terms of, I've heard some people reference the municipal market is generationally attractive, and I think that bears some credence, and it's important to be thoughtful about that. We just went through a period of ZIRP with extremely low interest rates, really frustrating to be in the market, trying to add value to portfolios or clients and be thoughtful about where there can be opportunity. Dan, to your point before, the fact that that very steep 11 to 18, 11 to 20-year portion of the curve is really attractive. You can kind of extend risk without adding a ton of duration and still be very, very involved in the market from an outperformance standpoint if and when those interest rates do start to come down. So I think the opportunity is setting the stage for it. I always look back, after talking to clients, and thoughtful about when you miss a spot and when you miss a buy, and people tend to wait for it to come back again, and sometimes it doesn't. So I do agree that there's some opportunity in here for extending a little bit.

Daniel Close (46:31):

I think, though, Chris, it's been interesting to hear, and it's kind of picking up a thread from Dora, that advisors and clients are kind of tired of hearing the muni story where we've been kind of pounding our fist, and munis haven't done anything since '22. We're actually still negative, and from the beginning of '24 to now, we're still negative or flat. You go into an FA's office or you talk to a retail investor, and his or her screen is all green on this side, looking at equities, looking at Treasuries, MBS, ABS, core, core plus corporates, and then it's you got the slumpy-shoulder muni person in there kicking dirt from one shoe to the other, talking about how this time we really mean it, and we're really going to go in, and this is going to be the rally. It's been a really frustrating experience because we have this evangelical belief on our desk right now that this really is a generational time to be putting money to work in the muni market.

(47:33):

But I think as an industry, we lack credibility right now because it's been such a great buying opportunity for so long, but we haven't done anything. When we started citing the "Gosh, we're underperforming the Barclays Agg by 400 basis points. It's happened four times the last quarter century, it's been 11 months that you usually catch up," it's just gotten worse. You go in, and you see some of the same FAs, they're the same clients that are in your funds, and you ask to keep the faith. It's just really tough because everything else has rebounded since April besides us. When you are the worst performing fixed income asset class—and you could probably say it's maybe a couple of emerging markets going—when you are the worst performing asset class full stop, it's difficult to ask people to say, "Hey, now's the time to put in and buy a little bit more duration," and have faith that it's going to turn because we've been calling from the highest mountaintop about this opportunity, and it just hasn't come to fruition. I think the recency bias, especially in our market, has really, really inhibited our ability to get what we need most to get the NAVs and our funds up, which is flows.

Christopher Brigati (48:58):

Great. Dan, Ozi, any thoughts? Ozi?

Ozi Sander (49:00):

No, I think both Dora and Dan nailed it. I don't think I have anything to add there.

Daniel Close (49:09):

I've never heard you speechless. This is a turning point in our panel.

Ozi Sander (49:14):

I know, I know. I don't know. I don't know what that says about me. But I do have, when it comes to the treatments of the muni market, when non-muni people, especially on the desks here at Wells Fargo, ask me about munis, or when I have friends at home who ask me about munis, that's when I know it's probably starting to turn, just given the fact that there are people out there in the market who on a daily basis don't follow it. When they hear about after-tax yields of 8%, 9%, even 10% on some bonds in certain cities and states, that's attractive, especially given our default rates. So I think for the first time in a long time, the amount of conversations I'm having with non-traditional muni people, I think at least tells me that there's a floor and a defined bottom in our current ratio environment that you're supposed to start legging into it if you're not already in it.

Christopher Brigati (50:11):

Great point. I'm thoughtful of thinking of opportunities to get people involved. One thing might be a little bit of a Meredith Whitney type of scare, so stay tuned. I might throw something completely ridiculous out there, interested again. But I think overall, we're in a good spot from the asset class to perform well. Usually these things kind of revert to a mean, so a period of underperformance lends to a period of opportunity, and I hate to be the one trying to pound the table at times suggesting that, but this time it's different. To some degree, I think it is, but this time it might be a little bit different.

Ozi Sander (50:49):

Also, by the way, on the long end, we entered the year at 82% ratios, right? 82% is probably the tightest ratios we've had in a long, long time, right? Currently at 96%. That's significant underperformance so far this year, right? So to your point, Chris, we probably worried you for some normalization, and unfortunately, we didn't get it from a rate tightening. We had it from a spread widening, and at 82% to 96%, that's real underperformance.

Christopher Brigati (51:17):

100% agreed. We got about nine or 10 minutes left. There's a few things that we can kind of talk about. Any macro ideas for, all right, we got through the first half of the year, we know the performance numbers, we know where we've stood and how the opportunity set could come about. Looking forward, what do we expect for the rest of this year in the municipal space for high yield? Perhaps more projects? Obviously, could some big deals be coming down the pike? We don't know about. Answers to some of those questions, but what could we expect? Is there anything that might be of interest worth sharing with the audience? Dora, any thoughts on that?

Dora Lee (51:57):

In the high yield space, I think it's just, we'll have to see what the calendar looks like going into the end of the year. Maybe there's going to be one or two high-profile names coming to market that will really test investor appetites and really be kind of a bellwether for what investors are going to stomach. But I think probably, hopefully, the spotlight is going to be on high-grade issuance. It is just unrelenting.

Christopher Brigati (52:40):

Dan, any thoughts from you?

Daniel Close (52:42):

Yeah, we hadn't spent too much time on it, but I think the muni fundamental story will continue to be really good. I think that trickles down to the high yield space too. The Holy Trinity of muni taxes, which is your ad valorem taxes, your sales taxes, and your income taxes, you're up more than 5% in the most recent quarter. Municipalities, both high grade and high yield, are coming in with the highest level of reserves they've had, 2x that before even COVID. The fundamental story for municipals, I think, is especially on the high yield side, a very good one. I think that that story—Ozi had alluded to it—but when you have a 6% or so distribution rate for a lot of high yield muni funds, you're clipping, even if you don't have state income taxes, if you're in the highest tax bracket, that's a 10% taxable equivalent yield, which is approaching, for most people, an equity-like return from something that clips a monthly coupon in the 40 ACT space.

(53:55):

I think for our market, for high yield in particular, there will be, I think, certainly credit stories. I don't think it will be a credit story that goes in and takes down the market, but I think the fundamentals remain good. I think if we have the type of income levels stay close to where they are, I think the income generation is really going to be the story, especially if you get that Fed rate cut, the second rate cut. You move that $7 trillion or so that's in money market equivalents that are now going to be yielding 3.25%, 3.50%. I think you start to see that migration. I think I've been super encouraged. It's more on the high grade side now, of the amount of crossover buyers we're seeing from insurance companies, banks, names we usually don't hear on deals coming into our market.

(54:50):

The fact that Ozi's friends are talking about munis, the fact that I'm at a cocktail party, and usually the most uninteresting person with munis, and hearing that and the cheapness in our market, I think does give me some hope and faith that we're going to recover a bit. But I think if our fundamental story stays the way it is, and with starting yields being where they are right now, I think it's just going to take some time, and I think that's going to be the story in the second half of the year. No blockbuster events, but just kind of a grind higher from the income generation side.

Christopher Brigati (55:27):

Ozi dropped some knowledge on us.

Ozi Sander (55:29):

Yeah, I agree. I think that's probably the course of action for the next six months. The fact that we have—we recently did a deal, and I think I saw names on the order map that I haven't seen in five to seven years from crossover accounts. I think there's a defined floor in the market at current ratios. I think that's going to trickle down the credit curve, down the structure curve, down the duration curve, which I think is going to be a significant opportunity. I do think there's going to be the "haves" and "have nots" in the market like we've seen so far year to date. I do think that there are specific credit stories and more sectors that I think are going to underperform, just given some headline, some potential headline news. Higher education is one that comes to mind. Obviously, the pressure from the federal government on that sector specifically is something I'm a little bit concerned about.

(56:19):

But I think for the broader market as a whole, I do think that the crossover interest we have on ultra-high grades is going to leak into the rest of the market, and it's going to create a pretty substantial opportunity. I also think if you look at the current duration landscape—we touched upon it a couple of minutes ago—but if you want to go out there and buy $150 million to $200 million long healthcare fours, you're not really doing that without moving the market 25 to 30 basis points. If you want to go out there and buy $100 million long healthcare threes, I think that's a really difficult trade to put on right now. So I think that the market—the market's craving some sort of significant size bid, but I think it's going to be really hard for accounts to put on the trade if they're too late, and I think people are starting to understand that.

Christopher Brigati (57:09):

That's great. So we're kind of wrapping up here at the end. Thank you to the panel. Thank you for the Bond Buyer and Lynne for hosting us. I think hopefully this was informative to the audience as it was to me. I really love doing these things, and so always appreciate the opportunity to participate. Any final thoughts, anybody before we turn it back to Lynn?

Daniel Close (57:29):

Chris, I'll just say thank you for hosting. Really good questions. Thank you for the questions from the audience. Yeah, thank you, Lynn, so much for hosting today, too, and The Bond Buyer.

Ozi Sander (57:40):

Thank you.

Dora Lee (57:41):

Thank you so much.

Christopher Brigati (57:43):

Lynn, back to you.

Lynne Funk (57:45):

Thanks everyone so much. Thank you so much to the panelists; you all were wonderful. If anybody does want to read their bios, you should go to our website, and you can also check out the replay. Thanks again, and we'll see you all soon. Take care.