Salt River Project Seeks an Outlet for Its Electric System Revenue Bonds

Interest rate risk will generally continue to confound municipal bond investors in the week ahead, amid uncertainties over U.S.-China trade negotiations, along with several other intensifying global headwinds.

Reports over the weekend indicated that China has asked for another round of talks with the U.S. to discuss the so-called ‘Phase One’ trade deal – a partial resolution to the ongoing trade conflict – which U.S. President Donald Trump had announced Friday.

The progress had reportedly led to the U.S. suspending its planned tariff increase on US$250bn worth of Chinese imports, which was set to go into effect Tuesday, while further levies of 15% on US$160bn of imports slated for December 15 are apparently still on the table.

(Click on image to enlarge)

News of the ‘Phase One’ deal had helped market participants regain their risk-taking mojo, which had also been spurred along by some upbeat reports on consumer sentiment from the University of Michigan, as well as a solid reading on the domestic labor market.

The yield on the 10-year U.S. Treasury note had risen to 1.76% ahead of the weekend, a 29-basis point increase from its level at the start of September. Also, the inverted spread between the 3-month bill and 10-year note unwound for the first time since its brief positive turn on July 23.

Bond investors mulling the prospects for a final sign-off on the ‘Phase One’ deal are likely growing more skeptical about any substantial progress on the trade front, but the fixed income markets will need to await the reopening of the U.S. Treasury market Tuesday for any sign of impact.

The Securities Industry and Financial Markets Association (SIFMA) has recommended the close of trading of U.S. dollar-denominated government securities, municipal bonds, mortgage- and asset-backed securities, as well as over-the-counter investment-grade and high-yield corporate bonds, and related financial instruments, in observance of the Columbus Day holiday.

However, equity markets were active Monday, with the S&P 500 and NASDAQ both touching negative territory, with losses of 0.11% and 0.05% intraday, while the Dow Jones Industrial Average was about unchanged.

Meanwhile, analysts at Rareview Macro noted that while any de-escalation in the U.S.-China trade war will lead to a rebound in soft data, the latest negotiations may end as a replay of February’s truce, which “blew up in May once the Chinese got home and put their version of the agreement on paper.”

Rareview Macro added that there are already signs of this “with China wanting the December tariffs to be removed for them to sign an agreement next month.”

For now, the U.S.-China trade negotiations remain an overhang, along with a myriad of other global concerns, including an ultimate resolution to the UK’s departure from the EU; ongoing and escalating protests in Hong Kong; as well as rising tensions in the Middle East – notably Turkey’s involvement in Syria and uncertainties over Iran’s regional disputes with Saudi Arabia.

Munis Hold Steady Through Sell-Off

Against this backdrop, Barclays strategists observed that tax-exempt municipal bonds “were able to hold their ground,” as typically happens at times of sharp rate sell-offs, and MMD-UST ratios “meaningfully declined, especially for shorter-dated maturities, which were very cheap during the past week.”

(Click on image to enlarge)

Overall demand for municipal bonds, ex-exchange-traded funds (ETFs) improved, according to the latest flow of funds data.

Indeed, for the week ended October 10, Thomson Reuters/Lipper U.S. Fund Flows posted net inflows into muni bond funds (for the 40th straight week) of around US$1.14bn, up from the prior week’s US$906m, albeit slightly below their weekly average of US$1.15bn since August 7, 2019.

(Click on image to enlarge)

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 risen roughly 9.56% and 7.65%, respectively, since their most recent 52-week lows set in early November 2018. However, prices of these ETFs were somewhat lower in the latest week, in line with the sell-off in U.S. Treasuries.

(Click on image to enlarge)

Deals that priced this past week included the Massachusetts Water Resources Authority’s US$550m worth of revenue bonds at yields of 1.1% to 3.2%; the Michigan State Housing Development Authority’s US$325m of single-family mortgage revenue notes at yields of around 1.3% to 3.5%; and the University of Nebraska’s more than US$560m worth of university system facilities bonds at yields of about 1.1% to 3.2%.

New issuance is set to continue to rush forth in the week ahead to meet investors’ demand.

Barclays said that while supply this past week fell US$1bn from the prior week to around US$9bn, they expect issuance to pick up pace, with a potential US$12bn worth of new deals on tap for the coming week.

To date in 2019, almost US$290bn worth of fresh muni bond issuance priced, with the Bond Buyer’s U.S. 30-day visible supply signaling another US$16.9bn intraday Monday, according to Bloomberg.

Looking for an Outlet

Among the deals on the near-term radar, Arizona’s Salt River Project Agricultural Improvement and Power District (SRP) is set to sell nearly US$436.2m worth of Salt River Project Electric System Revenue Bonds, 2019 Series A, to finance its ongoing capital improvement program, as well as to pay issuance costs.

The fixed-rate bonds, maturing January 1, 2021, to January 1, 2049, have been assigned ‘AA’ investment-grade credit ratings by both Moody’s Investors Service and S&P Global.

According to Moody’s, SRP’s bonds are secured by a pledge of and a first lien on the net revenues of
the electric system. The rate covenant is sum-sufficient; there is a 1.10x additional bond test; and a debt service reserve requirement in the bond resolution, which is set at one-half the average annual interest cost for all SRP’s outstanding revenue bonds.

As of July 1, 2019, SRP had around US$3.62bn worth of revenue bonds outstanding.

Moody’s analyst Gayle Podurgiel noted that a “key SRP strength is its well managed financial operations and conservative financial planning.”

She observed that debt service coverage ratios have averaged 2.5x over the past 5 years, with most surplus financial margins used to fund SRPs ongoing capital improvement plan.

(Click on image to enlarge)

SRP expects to use internally generated cash to fund 89% of the US$4.15bn slated for capital improvements between 2020-2025. The remaining 11%, she said, will be debt-financed.

Podurgiel continued that most of the capital improvement plan is funded on a pay-as-you-go basis. “This has a smoothing effect on SRP’s debt ratio, which has been stable since 2014 at around 50% (unadjusted for pensions).” Furthermore, SRP “maintains strong liquidity with strong fund balance policies and an authorized commercial paper program.”

In fact, the strength of SRP’s financial profile and solid economic fundamentals has spurred some in the market to raise their views on the health of the utility’s credit metrics.

S&P Global, for example, recently upgraded its credit rating on SRP by one notch to ‘AA+’ from ‘AA,’ partly on the back of a “very strong operational management assessment,” a “strong market position,” debt-to-capitalization of 47% in 2019, “which is extremely strong,” and very “strong liquidity.”

(Click on image to enlarge)

S&P Global Ratings credit analyst David Bodek also attributed the lift to SRP’s “very strong enterprise profile and an extremely strong financial profile; fixed charge coverage metrics that have consistently been extremely strong and that we expect to remain so; and the availability of unrestricted, segregated funds that provide flexibility that enhances our assessment of liquidity as very strong.”

SRP’s latest issuance is being lead-managed by J.P. Morgan and is expected to price on Wednesday, October 23, 2019.

In the meantime, other deals on the near-term horizon include around US$2.5bn worth of general revenue bonds from New York State’s Thruway Authority, with roughly US$1bn as taxable issuance, as well as more than US$1bn of taxable GOs from the State of California.