Bay Area Toll Authority Adds to Mounting Supply of Taxable Transactions

Issuers of U.S. municipal bonds continue to benefit from ultra-low interest rates, while bondholders recover from recent losses.

Prices of U.S. government debt rose somewhat Monday following reports of a drone attack on Saudi Arabian oil facilities, as nervous investors generally fled to safe haven assets. The yield on the 10-year U.S. Treasury note was last bid at around 1.80% after reaching as high as 1.90% at the market close on Friday.

While geopolitical volatility had resurfaced with the attack on Saudi oil production, other global concerns appear to have eased, including U.S.-China trade tensions. Although the results of discussions between U.S. and Chinese officials remain widely debated, the talks set to resume at the end of the week have inspired some signals of progress – and a return of risk appetite.

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Furthermore, market participants widely expect a 25-basis point rate cut at the conclusion to the Federal Open Market Committee’s (FOMC) meeting Wednesday, which would lower the target range for the fed funds rate to 1.75% to 2%.

The 25bp rate cut probability, according to Bloomberg data, places the decision at close to 95%, with around 5% of estimates calling for a 50bp reduction.

Some analysts foresee Federal Reserve chair Jerome Powell’s justification for the potential lowering of the rate as a continuation of the “mid-cycle adjustment” from July’s meeting while highlighting optimism about the strength of the economy.

Jefferies economists, for example, recently noted that the “bottom-line of the Fed’s approach to policy is that they will do what is ‘appropriate to sustain the expansion’.” They suspect Powell will “reiterate the important relationship between global rates and the Fed’s policy decisions and he will provide a positive outlook on the economy despite the uncertain outlook.”

Any cut by the FOMC would come hot on the heels of the European Central Bank’s (ECB) latest multi-pronged stimulus package to help revive stubbornly low levels of euro area inflation.

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Still, the Fed is faced with the daunting challenge of cutting rates while the U.S. economy continues to indicate decent health – and as the recent surge in oil prices is likely to add to overall inflation levels.

Jefferies continued that “it remains the case that the two primary sources of weakness in the economy – fixed investment and manufacturing activity—are not interest-rate-sensitive, and so it is going to be a challenge for Powell to make the case that further rate cuts will have a strong impact on growth. It is also going to remain a challenge for Powell to say much about the future trajectory for interest rates since these sources of weakness in the economy are highly sensitive to the mercurial state of the trade war with China, which is impossible to handicap.”

Meanwhile, the yield on the 10-year U.S. Treasury note has risen by around 43bps since August 1, while 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 continued to slide– both having lost around 1.67% since their most recent 52-week peaks set in mid-August 2019.

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Rates had also witnessed upward pressure, amid an onslaught of investment-grade corporate debt issuance, which has tallied more than US$132.5bn month-to-date.  

Demand Intact

Against this backdrop, while municipal bond supply continues to cross the tapes, demand has tapered somewhat from recent weeks.

For the week ended September 11, Thomson Reuters/Lipper U.S. Fund Flows posted net inflows into muni bond funds (for the 36th straight week) of nearly US$880m, well-below their weekly average of US$1.39bn since August 7, 2019. 

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Analysts at Janney Montgomery observed that tax-free yields have continued their upward move, despite the renewed strength in the U.S. Treasury market, ending Monday’s session roughly 2.5 bps higher in most maturities.

According to Janney, Monday’s “soft” muni markets are continuing last week’s trend, which generated the largest weekly loss for tax-free bonds since the November 2016 post-election period – amounting to -1.77% per MMA. They added that this underperformance has pushed relative value indicators higher, with municipal-to-Treasury ratios improving to 84.7% and 97.3% for 10-year and 30-year maturities, respectively, higher in both cases than 2019 averages (79.1% and 96.1%).

Other strategists have noted that the sharp sell-off in the muni market has spurred a buying opportunity for institutional investors, amid still-sound fixed income fundamentals.

Nuveen analysts Bill Martin and John Miller recently said that they “believe the recent selloff is a reversal of a flight-to-get-invested rally. Investors bought fixed income out of fear that U.S. rates would be pulled down to zero, along with the rest of the world. These fears now seem unfounded.”

Taxable Deals on the Rise

While demand remains intact, a total of around US$10bn worth of new muni supply is expected to price in the week ahead, with taxable transactions accounting for almost 25% of the tally.

The uptick in taxable deals is largely due to the end of tax-free advanced refunding issuance, which had been used to repay existing debt – part of the Tax Cuts and Jobs Act of 2017.

Barclays analysts pointed out that taxable advance refundings of tax-exempts is “one of the main reasons taxable supply is increasing and poised to remain heavier in the coming months and possibly years.” They continued that various issuers have been responding to lower rates, including universities that are placing long-dated and century deals, as well as “increasing taxable issuance in the healthcare sector.”

Barclays added that new taxable issuance levels will likely “remain somewhat elevated if rates stay low, as we expect, providing more issuers an incentive to look at the taxable market,” and that next year’s supply may “easily get to” US$45bn-US$55bn, “although it will still remain substantially lower than in 2009-10.”

BATA Adds to Taxable Transactions

Among the larger deals on the radar for the week ahead, the Bay Area Toll Authority (BATA) has nearly US$965m worth of federally taxable revenue bonds on tap, almost 90% of which are comprised of 2019 Series F-1 Senior Lien notes, with the remainder being offered as 2019 Series S-9 Subordinated Lien debt.

BATA said it intends to use the proceeds from the sale of its San Francisco Bay Area Toll Bridge Revenue Bonds to refund all or a portion of certain of its outstanding debt obligations.

The senior lien portion of the deal, with serial maturities ranging from April 1, 2023-2031, has been rated ‘Aa3’ by Moody’s Investors Service and ‘AA’ by both S&P and Fitch Ratings.

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Moody’s attributed its ‘Aa3’ senior lien ratings on BATA’s “near monopoly of bridge crossings in the economically strong San Francisco Bay metropolitan area, strong demand for its seven bridges as evidenced in sustained traffic and revenue growth, and independent ability to increase toll rates.”

However, with over US$9bn of debt outstanding and 12.6x adjusted debt to operating revenue in FY 2018, BATA’s leverage is among the highest for Moody’s rated established toll roads and continues to be one of its more significant credit risks. Another risk is BATA’s relatively high exposure to market access and interest rate risk, with 30% of its debt portfolio in variable rate bonds, half of which is unhedged. As such, the ratings agency underscored that BATA’s policy to maintain liquidity levels at or above US$1bn is “essential” to the stability of its ratings.

BATA also boasts eight years of “strong growth,” with increases in traffic moderating at near-record levels. Since fiscal year 2011, traffic has risen 15%, a compound annual growth rate (CAGR) of 2.1%.

Moody’s lead analyst Myra Shankin further noted that BATA’s debt service, on a Moody’s net revenue basis, “remains solid,” at 2.00x and 1.35x in FY 2018 for the senior lien and total debt, respectively. The refunding associated with the current offering results in annual debt service savings through FY 2055, with an estimated savings of more than US$250m.

Shankin added that the transaction also slashes US$65m from its outstanding debt pile, which has a slight positive impact on the authority’s leverage, reducing it by an average of 10bps annually through FY 2024.

Bank of America Merrill Lynch and Citi are co-lead managing the sale, which is scheduled to price on Thursday, September 19, 2019.