We were due for another head fake and we got it last week. After a slew of consistently strong economic data set the bond market back on its heels, a surprisingly weak non-farm employment report sparked a much-needed rebound on Friday. After reaching their highest levels in almost two years last Thursday, 10-year and 30-year Treasuries have now rallied back to close at 2.64% and 2.74%, respectively, on Monday night.
The municipal market was a model of stability last week even as the Treasury market gyrated with each and every economic release. This allowed inter-market ratios to improve meaningfully: as of Thursday and on a week-to-week basis, Barclays reported that the 10-year muni-to-Treasury ratio fell five percentage points to 100% and the 30-year ratio improved by 4 percentage points to a still lofty 112%.
As we head deeper into August, the tax-exempt market is running out of time for a significant rebound, as supply/demand dynamics tend to worsen in the fall. The amount of bond redemptions usually tapers off while the visible supply will tend to rise.
New Issue Market
This week’s $8 billion calendar will have a little something for everybody. The competitive supply will include several high quality State G.O. offerings, from Washington to Minnesota to Alabama. The negotiated side will feature a $1.8 billion issue from the South Carolina Public Service Authority (a.k.a. Santee Cooper) with a mix of tax-exempt and taxable bonds. The University of California Medical Center (Aa2/AA-/AA) will try to capitalize on resurgent demand for quality CA paper with a $635 million offering. The Pennsylvania Turnpike will also be in the mix with a $220 million issue rated A1/A+/A+.
Yield-oriented buyers may want to consider the City of Chicago’s $250 million O’Hare Airport issue, rated Baa1/BBB/NR. Based on preliminary price talks, we find the 2038 maturity with Assured Guaranty insurance to be the better relative value at a proposed 5.75% yield, only 20 basis points lower than the un-enhanced 2043 maturity at a proposed 5.95%.
Of course, the issue most likely to capture the market’s attention this week will be the $600 million Puerto Rico Electric & Power Authority (PREPA) deal. On Friday, as we were going to press (electronically speaking) with our article on PREPA, the Puerto Rico market fell apart, with spreads widening by as much as 50 to 80 basis points compared to a month ago. Longer maturity PREPA block trades of $1 million or more actually traded above 7.00% (7.14% to be exact) by Friday’s close. PREPA credit spreads are now closing in on the +300 mark, a huge move from +203 at the end of June.
At this writing, the PREPA deal’s 2036 maturity is expected to price at a 6.75% coupon to yield 7.05% and the 2043 at a 7.00% coupon to yield 7.15%. Again here, in our opinion, the 2036s looks to be the better relative value, as the lower dollar price around 96.60 may provide more short-term upside.
While the adjustment in PREPA yield levels was understandable going into this week’s new issue, we found it more disturbing that the COFINA sales tax bonds, widely viewed as the best credit in Puerto Rico, also traded down to a 6.25% yield or +212 versus AAA, compared to 5.41%/+159 on June 28th. Clearly, COFINA bondholders have also gotten queasy about the outlook for the PR economy, after seeing the most recent economic indices released by the GDB.
If you already have significant exposure to PR bonds, as most specialty state funds do, the latest bout of spread widening certainly adds insult to injury, coming on top of the general rise in yield levels (and resulting price declines) since the end of May. This, of course, illustrates the kind of spread risk we warned you about back on May 30th, in a column entitled, “The Real Risks In Munis”.
On the other hand, if you’ve been prescient enough to lighten up a bit on your PR holdings, even as recently as the end of June, when PR spreads temporarily tightened again, the new 7.00% yield target could be an attractive re-entry point, depending on your investment parameters. After all, since new non-rated senior housing deals (among the riskiest in the high yield sector) are still getting done around 7 ½%, you should ask yourself: which is the better relative value?
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.
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