NY State’s Dormitory Authority Unleashes US$3.2bn Deal
Investors of municipal bonds have seen a mammoth rise in taxable new issuance in 2019, amid still ultra-low U.S. interest rates – a trend that is uncertain to continue in the new year.
A string of lingering headwinds in 2020, including the U.S. presidential election, a potential ‘no-deal Brexit,’ mounting corporate and household debt amid dovish central bank monetary policies, and slowing global growth, has effectively kept rates at bay.
The culmination of these concerns has generally left the door open for taxable municipal bond transactions, which have soared by more than 142% to date in 2019 over the prior year to nearly US$56.17bn, according to data compiled by the Securities Industry and Financial Markets Association (SIFMA).
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Another reason for the uptick is likely due to the termination of tax-exempt advance refunding bonds in 2018 when many investors looked to similar, taxable deals to fill the void.
Strategists at Barclays, for example, recently noted that over the span of just a few months, taxable advance refundings accounted for almost 40% of the taxable muni supply in 2019 – “boosting taxable’s supply share of total issuance, as well as making 2019 the largest taxable muni supply year since 2010.”
Barclays noted that the resurgence of taxable muni supply has been “one of the main stories in 2019 and probably the largest variable going into next year,” depending on the direction of U.S. interest rates.
As they anticipate U.S. Treasury rates will remain in a relatively narrow trading range for most of 2020, they foresee total issuance amounting to around US$410bn to U$420bn, an increase of about 4-5% year-on-year. However, should government bond yields rise, they would negatively affect tax-exempt issuance, with an even larger impact on taxable supply.
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Rising Interest-rate Risk
Indeed, the threat of rising U.S. interest rates appears to have increased after a solid November jobs report bolstered confidence about the labor market and overall domestic economy, as well as amid an easing of global trade tensions, further clarity on an ultimate resolution to UK’s exit from the EU, better-than-expected Chinese factory production and retail sales, and an improved German business climate.
The yield on the U.S. 10-year note was last bid at around 1.884% Wednesday morning, a jump of nearly 41.5 basis points from its recent trough at the start of September.
Against this backdrop, market participants will most likely continue keeping a close eye on incoming data for any signs that may spur a shift in the Federal Open Market Committee’s (FOMC) stance on monetary policy, after maintaining the federal funds rate at its target range of 1.5%-1.75% at its latest meeting in December.
The FOMC largely attributed its decision to a “strong” labor market, economic activity that has been rising at a “moderate rate,” along with a “strong pace” of household spending. However, the Fed pointed out that business fixed investment and exports remain “weak.”
Nuveen analysts Bill Martin and John Miller said they think the Fed is “less likely to continue easing policy from here,” with no member of the FOMC anticipating cutting rates in 2020 and a large majority expecting to remain on hold.
Martin and Miller added that beyond next year, “a majority believes the Fed will eventually raise rates as inflation climbs” to or above the central bank’s 2% target.
Recent quotes about the future implied probability the central bank will elect to cut rates by 25bps peaks at around 38.5% in 2020 at the conclusion to its last scheduled monetary policy meeting on December 16, with the majority anticipating no change throughout the year and into January 2021.
The Allure of Muni Bonds Remains Intact
Meanwhile, fixed income investors generally continue to find municipal bonds attractive.
Analysts at Janney Montgomery observed that tax-free yields on municipal securities edged higher to begin this week, outperforming taxable issuance and pushing the 10-year Muni to Treasury ratio lower to 78.3%, while Municipal Securities Rulemaking Board (MSRB) volume of US$9.5bn was “slightly ahead of average” for a Monday.
Janney added that although the new issue calendar is “light” this week, bid wanted totals reached a five-week high of US$861m, “likely reflecting portfolio fine-tuning” ahead of year-end.
For the week ended December 11, Refinitiv Lipper U.S. Fund Flows posted net inflows into muni bond funds (for the 49th straight week) of around US$1.4bn, up from the prior week’s relatively paltry US$411m and exceeding their four-week moving average of roughly US$1.34bn.
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Also, prices of certain exchange-traded funds (ETFs), such as the iShares National Muni Bond fund (NYSEARCA: MUB) and the Vanguard Tax-Exempt Bond fund (NYSEARCA: VTEB), have been holding onto recent gains. To date in 2019, the funds have increased by roughly 7.0% and 7.25%, respectively.
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Demand for recent individual offerings has also been decent, with nearly US$900m worth of Foothill Eastern Transportation Corridor Agency toll road revenue bonds having sold at yields ranging from about 3.8% to a little more than 4.0%, and US$700m worth of State of Connecticut general obligation (GO) bonds, which priced to yield around 1.2% to 2.9% to maturity.
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Down at the Dorm
In new supply, the Dormitory Authority of the State of New York (DASNY) is slated to offer one of the heavier municipal bond offerings in recent weeks, with more than US$3.2bn worth of ‘AA’-rated, state personal tax revenue bonds.
According to the issuer’s official statement, New York State expects state personal income tax and state sales tax revenue bonds to be the primary financing vehicles for state-supported programs over the current fiscal plan period.
The DASNY deal, comprised of roughly US$1.9bn and US$33.7m worth of tax-exempt, general-purpose bonds (Series 2019D and Series 2019E), as well as US$1.3bn in federally taxable securities (Series 2019F), is scheduled to be offered to retail and institutional investors via a negotiated sale on December 17 and December 18, respectively.
In line with the state’s funding objectives, the issuer intends to use proceeds from the sale to finance or repay the costs of various state capital projects and programs, as well as to refund certain of its outstanding state-supported bonds.
The issuance, which is being co-lead managed by Morgan Stanley, Jefferies, and Ramirez & Co., is secured by a pledge of payments detailed in a financing agreement between DASNY and the state’s budget director, with the bonds’ backing evenly split between receipts from New York State’s personal income tax and those of the its new Employer Compensation Expense Program (ECEP).
Moody’s Investors Service analyst Marcia Van Wagner pointed out that as part of the deal’s structure, the state comptroller will deposit the dedicated personal income tax and ECEP receipts into the revenue bond tax fund upon certification of revenues by the commissioner of the state’s Department of Taxation and Finance.
She noted that there “must be a legislative appropriation to pay debt service and the monthly financing agreement payments must be made in order for receipts in excess of debt service requirements to be transferred to the general fund and used for any other purpose.
“While the legislature has no obligation to appropriate the funds, this structure provides a very strong incentive to appropriate since the state relies heavily on the excess revenues to meet its budgetary needs.”
Governance Risk
While New York State is touted as the fourth-largest U.S. state by population, with a per capita income of more than 125% of the nation’s average, and gross state product of over US$1.5tn, it apparently suffers from disproportionate rates of annual growth in terms of budget and citizenry.
Speaking on an IBKR’s Traders’ Academy course on the U.S. Municipal Bond Market, Ed Grebeck, a global debt strategist and CEO of Tempus Advisors, highlighted that New York State’s budget in 1978 was in the area of US$16bn and has grown to about US$175bn in its 2018/19 fiscal year. This represents a compound annual growth rate (CAGR) of around 6% over the past 40 years.
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He continued that, over the same period, New York State’s population “has been pretty much stagnant,” having grown from about 17.5m in 1978 to around 19.5m today, a CAGR of roughly 0.25%.
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Grebeck added: “What business would actually grow that fast when basically the economy is shrinking? That’s what I call governance / political risk.”
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Meanwhile, the Dormitory Authority of the State of New York SUNY recently sold US$650m of facility-related revenue bonds at yields of around 1% to 3%, and New York State priced US$910m worth of general obligation taxable refunding notes at yields of between 1.8% and 3.29%.
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