Munis end week, Q1 on a quiet note; California deals top the slate

Bonds

Municipal bonds finished trading little changed Friday as the market rode out the end of the month and the first quarter on a calm note as Treasuries strengthened and stocks surged.

While munis came into March like a lamb, they went out like a lioness, calm and proud.

The two-year muni-Treasury ratio was at 58%, the three-year at 59%, the five-year at 61%, the 10-year at 65% and the 30-year at 89%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the two-year at 58%, three-year at 58%, the five-year at 59%, the 10-year at 64% and the 30-year at 90% at 3 p.m.

Supply is decent for a holiday-shortened trading week. The market is closed on April 7 for the Good Friday holiday; trading resumes Monday, April 10.

Volume is estimated at $6.2 billion for the week of April 3, with $5.44 billion of negotiated deals and $759.2 million of competitive sales slated. The week’s biggest deal is coming out of California, with the state set to sell over $2.5 billion of general obligation bonds.

Supply so far this year has been abysmal. In March, volume fell 30% on a year-over-year basis to $31.8 billion from $45.6 billion in 2021. Results were not much better for the first quarter, with volume falling 27% to $75.4 billion from $103.5 billion in the first quarter of 2022.

Secondary trading was relatively subdued for most of the week after recent volatility in the markets. Municipals were steady Monday and Tuesday and remained little changed in Wednesday trading. Munis became slightly firmer through most of the curve on Thursday.

Market technicals remained strong on Friday, with an overall balanced tone and slight level of optimism, according to two municipal experts.

A lack of supply is decreasing the overall market turnover and dampening volatility for tax-exempts, according to Wesly Pate, senior portfolio manager at Income Research + Management.

“A lack of supply continues to buoy the market even amid volatility in other asset classes as evidenced by ratios hovering around 60% for much of the intermediate curve,” Pate said.

Supply for the year is way down compared to last year, he noted, and that is making full-year market expectations appear incrementally more difficult to achieve.

“The tax-exempt market remains starved for bonds as supply over the last two decades has fallen well short of both demand and the supply seen in other asset classes,” he said, noting over the last 20 years, the municipal market has grown only 50%, while the broader taxable market has more than tripled in size.  

“The supply imbalance leaves us expecting ratios to remain compressed over the near future relative to longer term averages,” Pate added.

Meanwhile, investors are taking the current climate of uncertainty and volatility in stride, according to another municipal player.

“Folks are aware of possible pressure that could weigh on the market, but attitudes are still generally more constructive than negative at this time,” said Tom Kozlik, head of public policy and municipal strategy at HilltopSecurities. 

“We are not seeing evidence of meaningful strain from the financial sector in the municipal bond market on the primary or secondary side,” he said.

New issuance has not been negatively impacted and the primary market is behaving orderly — although a supply shortage continues to hang over the market, Kozlik noted.

“Another light week of primary market issuance is expected next week, but that is not too surprising based on issuance over the first three months of the year,” he said. 

Many investors are putting available cash to work, while others are being more discriminating about the market.

“Some believe market technicals are not as attractive as they would like,” Kozlik added.

BofA cuts ’23 volume estimate by $100B
BofA has revised its 2023 issuance forecast down to $400 billion.

“The large muni market rally since November 2022 has thus far failed to meaningfully alter the low new money issuance pattern,” BofA wrote in a weekly market comment. “We may need to wait until deep into the second half to see a clear shift. We revise our 2023 issuance forecast down from $500 billion to $400 billion to reflect the persisting pattern and the time lost.”

BofA said in the first quarter, a low new money issuance pattern appears to be persisting, signifying that the change since November is here to stay for a while.

“We likely will need to wait until the third quarter to see some meaningful change when we expect the 10-year AAA to fall below 2.00%. If so, better new money issuance later in the year should bring the total to a slightly higher level. Our revised estimate for new money issuance is $320 billion,” BofA said.

“Going forward, we believe a 2.00% 10-year AAA rate should bring about a material increase in refunding activity,” BofA said. “Still, this is mostly likely for the second half of 2023. So, we cut our refunding volume estimate to $80 billion. Please note that the $80 billion of refunding is close to 2022’s $81 billion of total refundings.”

BofA said March proved to be a good month for high-grade investors with the 10-year AAA muni yields falling 34 basis points in a bull steepening move and credit spreads widened.

“Munis did not follow the recent bear flattening in Treasuries in the banking sector stabilization trade. Bull flattening should begin if inflation and economic data weaken more than market consensus,” BofA said. “High-grade investors may employ barbell strategies to outperform the intermediate part of the curve. Credit investors should adopt a more tactical approach to manage through an economic downturn.”

Friday’s AAA scales
Refinitiv MMD’s scale was unchanged across the board on Friday. The one-year was at 2.49% and 2.38% in two years. The five-year was at 2.22%, the 10-year at 2.27% and the 30-year at 3.33% at 3 p.m.

The ICE AAA yield curve was bumped up to two basis points: 2.52% (-2) in 2024 and 2.42% (-1) in 2025. The five-year was at 2.19% (-1), the 10-year was at 2.27% (-1) and the 30-year was at 3.36% (-2) at 3 p.m.

The IHS Markit municipal curve was unchanged: 2.47% in 2024 and 2.36% in 2025. The five-year was at 2.19%, the 10-year was at 2.25% and the 30-year yield was at 3.29%, according to a 3 p.m. read.

Treasuries were stronger as equities rose.

The two-year UST was yielding 4.07% (-7), the three-year was at 3.83% (-8), the five-year at 3.61% (-7), the seven-year at 3.56% (-7), the 10-year at 3.49% (-6), the 20-year at 3.82% (-6) and the 30-year Treasury was yielding 3.69% (-5) at 3 p.m.

The Dow Jones Industrial Average was up 1.07% in late trading while the S&P 50 rose 1.21% and the Nasdaq gained 1.53%.

Secondary trading
This week’s NYC GO 4s of 2050, originally priced Wednesday at 95.083 to yield 4.31%, traded 64 times on Friday in a total amount of $51.85 million at a high price of 98.375 to yield 4.10% and a low price of 95.083 to yield 4.31%, according to the MSRB’s EMMA website.

The NYC GO 5.25s of 2047, originally priced at 111.326 to yield 3.87%, were traded seven times in a total amount of $1.3 million at a high price of 111.941 to yield 3.80% and a low price of 111.326 to yield 3.87%, according to EMMA.

Massachusetts 5s of 11/1/2048, originally priced in December at 109.214 to yield 3.87%, traded in a block of $5 million-plus+ at price of 110.994, a yield of 3.63%, according to ICE. Massachusetts 5s of 11/1/2052, originally priced at 108.87 to yield 3.91%, traded in a block of $5 million-plus at price of 110.313, a yield of 3.71%.

HJ Sims: How munis fared in March
The municipal market was the beneficiary of many haven trades in March, Gayl Mileszko, director of capital markets analysis and commentary at HJ Sims wrote in a blog post.

“State and local bonds are typically ranked just below U.S. Treasuries in terms of relative safety and munis tend to outperform during Fed tightening cycles, but are also clearly impacted by bank lending practices as well as bank purchasing and sales,” she said.

“Banks on a combined basis own approximately 15% of the $4 trillion of outstanding municipal bonds, or $592 billion,” she added. “Silicon Valley Bank reportedly held $7.4 billion of munis as of Dec. 31, Signature Bank reported $247 million and First Republic carried $19.4 billion.”

Why do munis often outperform other asset classes?

“There are times when munis outperform their taxable counterparts for technical reasons: demand for tax-exempts exceeding supply especially during heavy redemption periods (months with high maturities, calls, coupons available for reinvestment), fund flows, and after-tax ratios, for example,” Mileszko said.

She said that right now, as has been the case since December, muni yields are also unusually askew and trade flow is off.

“The one-year AAA rated municipal general obligation bond benchmark yields 2.49% well above the 11-year at 2.37%, so the short end of the muni yield curve is still inverted as it has been since early December,” she said.

“For borrowers, rates are still extremely favorable: the 10-year muni benchmark yield is 2.29% and the 30-year is at 3.35%. Since the banking crisis events began, the 10-year yield has fallen 32 basis points and the 30-year is down 23 basis points,” Mileszko said, adding, “Mutual bond fund inflows are still positive on a year-to date basis with high yield funds taking in the highest net at $1.17 billion.”

GOs or revenue bonds: Which is safer?
“Many investors believe GO bonds tend to have lower credit risk than revenue bonds do, as GO bond payments are funded by much broader and more diversified sources of potential income streams than revenue bonds,” John Bonnell, portfolio manager and managing director at Thornburg Investment Management, said in a recent blog post.

“This is a common myth and we believe it can lead investors astray when they are evaluating the true risks of GO vs. revenue bonds,” he says.

Bonnell cited two instances of stress — Detroit and Puerto Rico to illustrate his point.

“The Detroit bankruptcy story serves as an invaluable lesson for municipal bond market participants,” he said. “In July 2013, Detroit filed the largest municipal bankruptcy in U.S. history, defaulting on several hundred million dollars of its GO bonds. The city continued to keep essential services running and was able to make 100% of its payments on water and sewer revenue bonds.” He said the resulting payout structure helped disprove the long-held belief that GO bonds were the safest municipal security out there.

The Puerto Rico debt crisis, Bonnell said, serves as another example where payments to GO bondholders are not as certain as one might think.

“In 2016, the Puerto Rico government decidedly told its creditors it would not fulfill its GO debt obligations of roughly $800 million, even though these bonds were explicitly backed with a ‘constitutional priority’ when issued,” he said. “In this case, the unfortunate outcome for GO bondholders was significant haircuts in their recovery.”

The differential in risks and income stability between GOs and revenue bonds can vary greatly, Bonnell said, depending on the legal status of what is pledged for repayment and the values and priorities of those in charge at the time the bond is due.

Each bond, whether GO or revenue, must be carefully examined on a case-by-case basis with a discriminating eye, he said.

“While GO defaults have been rare historically, when governments do go into bankruptcy, the dollar volume of debt defaulted on can be quite large in comparison to revenue bonds,” Bonnell wrote. “In other words, although GO bonds tend to have higher credit ratings and default less, when they do default, the damage is far greater than that of revenue bonds.”

He noted revenue bonds are not without their risks as they make up the larger percent of defaults.

“However, despite their higher frequency of default, the total default loss is usually less severe,” he said.

NYC deal received warmly
New York City said Thursday that it received good response to the biggest sale of the week — its $1.19 billion of general obligation bonds that went off on Wednesday.

The issue was comprised of $950 million of tax-exempt fixed-rates and $240 million of taxable fixed-rates. Proceeds are being used to fund capital projects.

The city said it received over $698 million of orders during the one-day retail order period and almost $1.77 billion of orders during the institutional order period, which made the deal two times oversubscribed.

Given investor demand for the tax-exempts, yields were cut one basis point in 2025 and 2026, two basis points in 2035 and 2036, three basis points in 2037 and 2038, two basis points in 2045 and 2047 and by one basis point in 2050. Final yields ranged from 2.32% in 2025 to 4.31% in 2050.

The bonds were underwritten by lead manager RBC Capital Markets. BofA Securities, Citigroup, J.P. Morgan Securities, Jefferies, Loop Capital Markets, Ramirez & Co., Siebert Williams Shank and Wells Fargo Securities were co-senior managers.

The city also competitively sold $240 million of taxables, which attracted 11 bids. Wells Fargo won the bonds with a true interest cost of 4.665%.

Primary market
Two big deals are coming out of the Golden State in the upcoming week along with large sales from a Pennsylvania issuer.

Topping the new issue slate is the state of California’s (Aa2/AA-/AA/) $2.56 billion GO bond offering. BofA Securities is set to price the $1.38 billion of new money and $1.18 billion of refunding GOs on Tuesday.

Separately, the City and County of San Francisco Public Utilities Commission (Aa2/AA/NR/NR) is coming to market with $998.56 million of wastewater revenue bonds.

BofA and Goldman Sachs are set to price the PUC’s $536.60 million of Series 2023A sewer system improvement program (SSIP) green bonds, $285.25 million of Series 2023B non-SSIP GOs and $176.72 million of Series 2023C SSIP refunding green bonds on Wednesday.

Meanwhile, the competitive market is devoid of any sales over $100 million.

The largest issue going up for bid is coming from the Plymouth-Canton Community Schools in Michigan (Aa2///), which will sell $87.5 million school building and site GOs on Wednesday. PFM Financial Advisors is the financial advisor; Miller Canfield is the bond counsel.

Upcoming calendar
Other large negotiated deals on the negotiated slate include a spate of health care issues.

The University of Pittsburgh Medical Center will sell (UPMC: A2/A/A/) $400 million of taxable revenue bonds (corporate CUSIP). Underwriter: RBC Capital Markets. Pricing: Tuesday.

The Pennsylvania Economic Development’s Financing Authority will issue (A2/A/A/) $439.2 million of UPMC revenue bonds, Series 2023A, Subseries 2023A-1 (term rate mode) and Subseries 2023A-2 (fixed rate mode). Underwriter: RBC Capital Markets. Pricing: Tuesday.

And the Pennsylvania EDFA will also sell $90.55 million of Series 2023B UPMC refunding revenue bonds. Underwriter: Barclays Capital. Pricing: Tuesday.

Georgetown University A3/A-//) plans a sale of $300 million of Series 2023 taxable fixed-rate bonds. Underwriter: Barclays Capital. Pricing: Wednesday.

Durham County, North Carolina, (Aa1/AA+//) will sell $172.79 million of Series 2023A limited obligation refunding bonds with revenues pursuant to an installment financing agreement between Durham Financing Corp. and the county. Underwriter: PNC Capital Markets. Pricing Wednesday.

The Colorado Housing and Finance Authority will issue (Aaa/AAA//) $104.84 million of taxable Class I Series F-1 single-family mortgage bonds. Underwriter: RBC Capital Markets. Pricing: Tuesday.

There are a few deals over $50 million on the competitive slate.

Alief Independent School District, Texas’ $79.89 million of Series 2023 unlimited tax school building bonds backed by the Permanent School Fund Guarantee program, will be selling Monday.

King County, Washington’s (Aaa/AAA/AAA/) $76.87 million of Series 2023A limited tax GO and refunding bonds, will sell Tuesday.

Brookhaven, New York’s $59.45 million of Series 2023 public improvement bonds, will be selling Wednesday.

Darien, Connecticut’s $72.42 million of bond anticipation notes, will sell Thursday.

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