Week of 9/16/2019

Taxable Munis See Best Gain Since 2015 On Global Hunt For Yield… Cash Fleeing Negative Yields Spurs Big Gains For Taxable Muni Bonds… Yields Are Horrible But Muni Analysts Say They May Fall More… Higher State Funding For Charter Schools, Credit Positive… Higher U.S. Yields Offer Window For Income For Global Investors… “Significant Progress” To PREPA Restructuring…

Taxable Munis See Best Gain Since 2015 On Global Hunt For Yield…Investors fleeing negative yields overseas are helping push taxable municipal bonds to the biggest monthly gain in almost five years. U.S. state and local government securities that don’t qualify for tax breaks, and pay higher yields than traditional municipal bonds have returned 3.5% since the start of August, the biggest one month gain since January 2015, according to the Bloomberg Barclay’s index. That’s over 2 percentage points more than tax-exempt bonds (Albeit munis are tax-exempt) and compares with 2.4% for U.S. corporate debt. The demand reflects a larger push into U.S. capital markets from abroad, where the yields on government debt in Japan and much of Europe are holding below zero amid concern about a global economic slowdown. Deutsche Bank AG said this week that global money managers have “no other alternative” than to buy “significant amounts” of U.S. Treasuries and corporate bonds, with global yields so low. Taxable municipal bonds are an alternative to corporate bonds for foreign buyers who are frustrated with those negative yields in their home countries, said the head of municipal research at Oppenheimer & Co. Just about $16 trillion of global debt is yielding at subzero rates, down from a record high of $16.7 trillion on August 15. Oppenheimer said, “I think we are going through very unusual times with the amount of global negative yielding debt. Taxable municipal bonds are very appealing, extremely appealing, in this global environment for a high number of foreign buyers. You really have to be motivated by the yield advantage. Before the summer this dynamic was there, but now that has grown to become even more compelling.” Strategist at Bank of America Corp, the largest underwriter of state and local government debt, suggests investors consider buying taxable municipal bonds.

Cash Fleeing Negative Yields Spurs Big Gains For Taxable Muni Bonds…Taxable Build America municipal bonds, debt issued by states and cities in 2009 and 2010 as part of the federal government’s program to pull the economy out of the recession, have returned more than 17% this year as negative interest rates in Europe and Japan cause investors there to shift money elsewhere. The gain is more than twice that of U.S. Treasuries. “Negative interest rates globally have brought foreign investment into municipal bonds,” said the head of municipal strategy at BlackRock Inc. Build America Bonds (BAB’s) are one of the perfect avenues for them to express their muni interest. The BABs carry higher yields than traditional municipal debt because the interest payments aren’t exempt from the U.S. income tax. That was done intentionally to draw interest from overseas investors and other non-traditional buyers, channeling more money into American public works projects after the Great Recession. With concerns about a new global economic slowdown causing interest rates to plunge, the securities have attracted renewed attention as about $16 trillion of global debt yields less than zero. A portfolio manager for Goldman Sachs said some of the gain reflects the limited amount of available bonds. There were only about $186 billion issued before the federally subsidized program lapsed at the end of 2010. Goldman said the dynamics that have led to the out-sized returns should continue, leaving some more room for the bonds to run. “In the near term, it’s hard to see an environment where the demand for the BABS wouldn’t be there, and absent a big change in the supply picture, like a reintroduction of the BABS program, which is unlikely, it should continue. The size of the gains were also driven by the long maturities on the bonds, which were issued by American state and local governments that are at little risk of defaulting. A senior portfolio manager at Federated Investment Management Co. said the rally has come in tandem with the long-dated Treasuries, which have returned about 21%, according to the Bloomberg Barclay’s indexes. Many BABs also provide additional protection with make-whole call provisions, which require the governments to compensate bondholders for lost interest income if they refinance.

Yields Are Horrible But Muni Analysts Say They May Fall More…Yields on the longest dated municipal bonds are already at record lows but some Wall Street analysts say they still have further to fall. The $3.8 trillion state and local government debt market’s recent rally has driven the yield on top rated, tax-exempt debt due in three decades to 2%, the lowest since the Bloomberg benchmark was created in 2011. That’s more than a full percentage point less than they were paying five months ago, when even 10-year debt that’s less sensitive to swings in interest rates was yielding more than the 30- year securities are now. The rally has been caused by investors fleeing into havens as political uncertainty and an escalating trade war heightens fears that the U.S. economy will slow. Bank of America strategists predict that yields on the long dated municipal bonds could edge even lower to 1.85% by the end of the year, or even less if the trade war with China escalates. “Given our bull-flattening view, we believe that by year-end the 30-year “AAA” should hit the 1.85% area,” wrote a municipal bond strategist at Bank of America. “In the case that the U.S.-China trade war turns out to be intractable by October and a riskoff mode resumes, we would anticipate much lower yields for the 10-year “AAA”, that means 1% or so and for the 30-year “AAA”, the 1.60% area.” Despite its low absolute yield, 30-year state and local government bonds may still be alluring relative to Treasures, said the head of municipal strategy at Barclays Plc. “ We know absolute yields on munis seem horrible, but compared to Treasuries they’re not that bad”, said Barclays.

Higher State Funding For Charter Schools, Credit Positive…Higher state funding, improved authorizations and more transparency bode well for charter schools. Several states have enacted laws to bring funding for charter schools more in line with traditional public schools. Texas, Arizona and Colorado offer a bond guarantee program to improve capital access for charter schools. Texas legislation will expand guarantees for charter school borrowing from the Texas Permanent School Fund to $5.7 billion by 2022 from $1.5 billion two years ago. Georgia increased state funding directly while Colorado, Florida and Michigan mandated local school districts share more local tax revenue with charter schools. Texas, Minnesota and Tennessee have allocated state aid or grants to charter schools to maintain facilities in order to reduce reliance on operating reliance and donations. California’s new governor signed new law this year to increase transparency in charter school operations. The Charter School Growth Fund, a private not-for-profit that provides low-cost loans to charter schools, plans to expand its support to 1,350 charter schools in 2021 up from 980 schools in 2017. 2016 was the first year when state education agencies approved more charter schools than traditional schools. Although charter schools face political cross-currents, these initiatives improve prospects for charter schools and their bondholders.

Higher U.S. Yields Offer Window For Income For Global Investors…Opportunities to earn a higher yield have emerged amid a dynamic economic and geopolitical landscape. The yield on the benchmark 10-year U.S. Treasury note staged its largest weekly climb since June 2013 – just weeks after near record lows. The U.S. economy is at the forefront with steady retail sales, contained, stable inflation and strong jobs market. Investors are tuned in with trade talks with China. Higher oil prices in the wake of Saturday’s attack on key Saudi oil facilities could be a headwind to global growth amid a slowdown. Investors look out to the Federal Reserve’s meeting this week. For 36 straight weeks, investors have added funds to tax-free muni bonds. When comparing taxable equivalent yields, muni yields are higher than comparable U.S. Treasuries.

“Significant Progress” On PREPA Restructuring…Holdout bond insurers, National Public Finance Guaranty and Syncora Guaranty Inc., joined PREPA Restructuring Support Agreement (RSA) on September 9. The RSA now has the approval of 90% of uninsured legacy PREPA bonds and all of the bond insurers, which exceeds the minimum required 67% bondholder support. An effort to restructure PREPA’s debt dates back to July 2014. “Significant progress towards PREPA’s eventual debt restructuring and eventual transformation” has been made per Moody’s. “The addition of Syncora and National to the RSA provides significant certainty to the restructuring not only of PREPA’s bonds, but to the transformation of PREPA to a modern, efficient power utility able to deliver clean, reliable and affordable energy to the people and businesses of Puerto Rico,” Puerto Rico’s Oversight Board stated. RSA needs to be approved by the Title III Court. A court hearing is set for October 30. If completed, PREPA debt restructuring could be the third consensual debt exchange of Puerto Rico’s legacy debt.

Compare 30-Year taxable U.S. Treasury yield 2.3% to 30-Year tax-exempt muni bond yield “AAA” 2.14%; “AA” 2.39%; “A” 2.54%; “BBB” 3%. For investors in the 35% tax-bracket, a 3% tax-exempt yield is equivalent to a 4.62% taxable yield. Top rated tax-free bonds yield 93% of comparable taxable U.S. Treasuries.