Bonds: Munis
(New York)
Muni bonds have been on a relentless rally. Any advisor is surely aware of this because there is likely a lot of their client’s money in the space. The inflows have been so sharp, and the price action so swift, that average ten-year yields in munis are at 0.7%, the lowest since the 1950s. At the same time, the COVID pandemic has decimated local and state budgets and there is a $1 tn budget deficit. Worse, the federal government has no clear plans in place to help local and state governments, meaning such municipalities may not be bailed out any time soon.
FINSUM: So on the one hand you have soaring prices, and on the other, significantly eroding credit quality. In any normal circumstance this would be seen as a bubble. However, given that Washington does seem likely to offer some aid to local governments, a meltdown will probably be avoided—but not without some volatility along the way.
(New York)
There is alarm growing among muni bond investors as credit quality continues to deteriorate. During COVID there has been a widening gap in pension deficits among municipalities, and investors are keeping a close eye because it is leading to deferred pension payments. This is troubling for a number of reasons. Firstly, it digs municipalities into a bigger hole because they must pay interest on deferred payments; and secondly, it spooks bond markets and makes it harder for them to access liquidity. In other words, deferred pension payments, such as the nearly $1 bn one New Jersey elected to do in May, dig muni issuers into a deeper and deeper hole.
FINSUM: Pension recipients are very likely to be considered senior to bondholders, so this is a very alarming situation for investors.
(Chicago)
You might not pay much attention to them—most don’t—but closed end muni funds are an excellent deal right now. They are offering high yields relative to other fixed income peers. For example, you can readily get 5% yields on CEF muni funds, equivalent to an 8.45% taxable yield if you are in the top tax bracket. And to be clear, these are not junk muni bonds. The reason yields are so strong is leverage gained from borrowing money at short-term interest rates and buying longer-term bonds. That usually creates a risk that short-term rates could rise, causing losses. However, given the Fed’s position right now, that seems highly unlikely.
FINSUM: This is an ideal time to by CEF muni funds given the low rate risk and solid overall yields. Check out BlackRock’s MFT (5.39% yield), Putnam’s PMM (5.18%), or BNY Mellon’s LEO (5.56%).
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(New York)
Muni bonds are seeing yields way above average right now even as Treasury bonds linger near all-time lows. The reason why is that it is increasingly apparent that there has been a huge erosion in municipal credit quality alongside the lockdown. Costs have surged at the same time as revenues have plummeted, leading to a significantly deteriorated financial picture for municipal issuers. The has been exacerbated by the fact that municipalities have largely been unsupported by the Fed as opposed to corporate issuers. But the sell-off has created opportunity, as even AAA issuers are seeing big discounts and much higher than usual spreads to Treasuries.
FINSUM: This is all about careful credit selection, as there are big opportunities, but there may also be major pitfalls.
(Chicago)
The muni market is at an interesting crossroads. There have been big fears that the current lockdown might be a huge negative for muni credits. The lockdown not only raises costs, but it constrains tax revenue at the same time. On its own, this is a big threat. However, the Fed has set up a liquidity facility particularly for states and municipalities to borrow, which is a major help. That said, analysts say some credits will be excluded. The problem is that the Fed has put limits on the size of cities and counties able to participate, as well as fairly onerous language, such as municipalities having to promise that they cannot “secure adequate credit accommodations from other banking institutions”.
FINSUM: The Fed’s restrictions on this program are surely going to constrain its efficacy. So, on the whole this seems like good news, but not as good as investors would like.
(New York)
New York is the epicenter of the US coronavirus crisis, and the hit it is taking to its finances may be an example of the risk that the muni bond market is facing all across the country. Government revenue is taking a huge cut at the same time as expenditure to support the economy and its people is jumping. While the threat of a downgrade from its AA perch is only moderate, New York does have several other muni issuers that are looking much more dangerous. For example, the Metropolitan Transit Authority (MTA) and the Transitional Finance Authority (TFA). The MTA, which runs the subway and other forms of public transportation, has taken a massive revenue hit during the lockdown, with ridership down 90%.
FINSUM: Certain muni credits are gong to be devastated. For instance, even though the MTA is getting $4 bn from the recent CARES act, it is still yielding 5% versus the 2% it yielded before the Covid eruption.