The tax-exempt market treaded water last week as new issues were reasonably well-absorbed and secondary market activities remained relatively subdued. Now that tax time is over, market participants are waiting for signs that mutual fund flows will be returning to the positive column. If nothing else, advance refundings and bond maturities should boost re-investment demand by $17 billion in May and $34 billion in June.

A firm Treasury market will certainly be helpful, as concerns about the inflation threat continue to fade in the face of lackluster economic growth. While early predictions of a major economic disaster have proven overblown, the sequester is starting to have a significant impact on certain sectors and on some states. The FAA certainly tried to make it as annoying as possible to the average citizen, with its partial traffic controller furlough. It succeeded spectacularly: the ensuing airport delays elicited an immediate response from a U.S. Congress not known for getting anything else accomplished.

All of this will lead up to our monthly ritual of trying to predict Friday’s employment report. The consensus is looking for a +150k headline and unchanged unemployment rate at 7.6%. Ever since the FOMC has drawn a line in the sand regarding their jobless rate target, this economic release has become even more essential for setting the tone for the Treasury market. For context, we are told the May report (April’s data) has a tendency to print close to the consensus – surprising on the upside 38% of the time for an average of +82k and on the downside just 25% for an average of -54k.

On the tax-exempt side, the deal of the week, by far, is the Iowa Finance Authority issue for Iowa Fertilizer Co. (IFC), which is being priced today. At $1.2 billion, this will go down as the largest high yield municipal issue to date, accounting for the lion’s share of this week’s $5.8 billion calendar.

As always, muni investors should ensure they’re not accepting bond-like returns for equity-like risk, particularly at this stage in the interest rate cycle.

As we pointed out earlier, from a technical standpoint, the deal’s timing could not be better, with credit spreads at their tightest since the 2008 crash and absolute yield levels just off record lows. With the nation awash in cheap natural gas from the “fracking” boom, this new nitrogen-based fertilizer plant should enjoy a built-in feedstock cost advantage compared to overseas facilities, at least in the early stages. The project will also benefit from its location in the U.S. Farm Belt, right in the middle of its primary user market.

As another instance of market makers jumping to easy but false conclusions, some traders had expressed concern that the deal could be “a tough sell” coming on the heels of the West, Texas fertilizer plant explosion. In fact, as a Supplement to the POS points out, the culprit for the explosion was likely  solid ammonium nitrate (AN), a hazardous and explosive product whose industrial use has been steadily declining over the last few years. The Iowa Fertilizer plant is expected to produce liquid urea ammonium nitrate (UAN), a competing product that has similar nutrient properties as AN but is reportedly safer to handle and less volatile. So, ironically, the tragic event in West, Texas may actually end up highlighting the potential competitive advantage of this new Iowa facility. It may also lead to even stronger safety standards for the storage and transportation of volatile chemicals such as ammonia.

While this is not intended as a complete analysis of the credit by any means (potential buyers should really spend the time to digest this very complex transaction and understand all the risks involved), certain interesting features are worth noting. For one, the project is only 65% debt-funded, with more than $600 MM in equity funded upfront in cash. Much was made in the media of the fact that the parent company, Orascom Corporation, is headquartered in Egypt, with all the attendant political risk. To address such concern, IFC was structured as a bankruptcy remote entity, legally ring-fenced from its parent. Yet, it would be interesting to see how the bonds will trade should the world witness another event similar to the Arab Spring uprising.

From a credit rating standpoint, to the extent ratings still matter anymore, the upside may be limited. The issue is being marketed with a “BB-” rating from both S&P and Fitch. S&P has gone on record saying that, by its very nature, this project will never achieve investment-grade status. They did allow for a possibility for a modest upgrade to the upper end of the “BB” range once commercial operation is achieved successfully. We also note that Moody’s was not invited to provide a rating, which probably means they didn’t come down with a rating that would be helpful to the underwriter’s cause.

At the end of the day, we believe construction risk and commodity risk should be the key drivers for the IFC credit over the next two years. At this writing, the suggested yield on the 2025 maturity is around 5.40% to the 10 year par call, or about +346 over the MMD AAA curve. Interestingly enough, Puerto Rico paper and tobacco bonds with similar maturities are all trading in this range in terms of spread, although they are admittedly driven by completely different risk factors.

We do caution investors that, historically, the muni market has had a dismal record of gauging and pricing commodity risk. Anyone who was in the market in the late 1990s and suffered through the paper de-inking investment fiasco can attest to that (for more details, check out Chapter 2 in my book “Investing in the High Yield Municipal Market”). In what other market could a stand-alone project of this magnitude and with this kind of risk profile secure low 5.00% financing? Only in U.S. munis. As always, muni investors should ensure they’re not accepting bond-like returns for equity-like risk, particularly at this stage in the interest rate cycle.

Disclaimer: The opinions and statements expressed in this column are solely those of the author and Axios Advisors, who are solely responsible for the accuracy and completeness of this column. This column does not reflect the position or views of RICIC, LLC or MuniNetGuide.

The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice. Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.