With the reopening of the Federal government, the flow of economic data has resumed in earnest. The first major release out this morning was the September payrolls number, originally slated for October 4th. According to the Bureau of Labor Statistics, non-farm payrolls rose by 148,000 in September, falling short of the 180,000 Street consensus. However, August employment, originally reported as 169,000, rose a revised 193,000 and the unemployment rate dipped to 7.2% from 7.3% in in August.
Traders responded to the softer jobs data by pushing the benchmark yields on 10-year and 30-year Treasuries down to around 2.54% and 3.63%, respectively.
Truth be told, any stronger-than-expected economic data for September and early October will likely be dismissed by the market as pre-dating the debt ceiling crisis. As a result, it might take another couple months of data before we can assess the economic effect, if any, of the government shutdown and the ongoing fiscal uncertainty.
Given the events of the last two weeks, the Fed’s decision to defer its tapering effort now looks quite prescient.
For its part, the municipal market also bounced back after the debt ceiling was raised, but has failed to keep up with the move in Treasuries. As a result, the inter-market ratios in the 10-year and 30-year range have risen by about four percentage points to 101% and 115%, respectively, within a stone’s throw of the highs from early September.
New Issue Market
The key factor holding munis back is, of course, the visible supply, particularly with the mutual funds still experiencing outflows. Now that the Puerto Rico free fall has ended, at least for the time being, muni issuers are returning to the market with a vengeance: this week’s new issue calendar is expected to top $8 billion, almost double the $4.4 billion sold last week.
The negotiated slate of about $5.7 billion will be dominated by $2.25 billion in G.O.s from the State of California and $1.2 billion from Catholic Health Initiatives (split between a $602 million tax-exempt tranche and a $554 million taxable tranche). Other notable negotiated offerings include $650 million New York Transitional Finance Authority subordinate bonds and $585 million Northwestern University taxable bonds.
On the competitive side, G.O. offerings will be expected from the States of Minnesota and Pennsylvania, to the tune of $768 million and $750 million, respectively.
Many market participants are bemoaning the richer price talks on the California G.O.s. Even though the Golden State has regained fiscal stability, it has yet to make any attempt to reduce the extreme cyclicality of its revenue structure. In fact, it is arguably more dependent than ever on continuing strength in the equity market, particularly with regard to tech sector IPOs. Having said that, the proposed yields-to-maturity of 4.69% in 2032 (+92 versus AAA) and 4.975% in 2043 (+82) still look attractive to us for a high tax State G.O. credit.
Not all corporate-style restructuring concepts can be easily transferred to munis, particularly when politics are involved.
In contrast, we don’t see much relative value in the preliminary price talks for the Catholic Health Initiatives (CHI) deal, which was recently downgraded to A1 (negative)/A+ (stable)/A+ (stable) by the three rating agencies. This massive multi-state health system, with $12.5 billion in revenues and 87 hospitals spread across 17 states, is paying the price for an aggressive expansion strategy into such new markets as Houston. FY2013 turned out to be quite challenging and the system’s financial results took a big hit, which led to the recent downgrades. (For instance, the system’s operating margin has gone from 4.00% in FY2012 to a mere 0.20% in FY2013). Against this backdrop, the proposed spread to maturity of +130 vs AAA doesn’t look too compelling, in our opinion.
Given the relatively narrow window of approximately two months before Washington D.C. dysfunction rears its ugly head again, we believe there’s a high probability of a supply surge going into yearend. Many of these new issues will be priced to sell, so keep your powder dry.
Detroit Update
Not all corporate-style restructuring concepts can be easily transferred to munis, particularly when politics are involved. As a case in point, the Detroit City Council Monday unanimously rejected the $350 million debtor-in-possession (DIP) loan that emergency manager Kevyn Orr wants to obtain from Barclays Bank. Under the state’s emergency management law, the Council now has seven days to come up with an alternative plan that raises the same amount of revenue. If they fail to do so, the matter will end up in front of the bankruptcy judge.
Right from the start, the DIP financing was a political landmine. Mr. Orr is proposing to give Barclays a potentially very lucrative deal secured by a super-priority lien on income tax and casino revenues as well as on proceeds of more than $10 million on any sale of the city’s assets. As we discussed in an earlier column, this has the potential of further subordinating the interest of the “unsecured” creditors, including the city’s retirement systems. Furthermore, much of the proceeds of the DIP loan will go to settle the swap liabilities due Bank of America and other banks. This all smacks of putting Wall Street before Main Street, of favoring the interests of the banks at the expense of retirees. No wonder City Council members decided to punt and leave it up to the bankruptcy court to decide, particularly since the Chapter 9 eligibility trial is scheduled to start tomorrow.
This morning, several retiree groups also filed suit against the city over steep cuts to their health insurance coverage announced last week. Never mind that the city is already protected by a stay ahead of the bankruptcy hearings. But then again, why not sue since all legal fees are paid by … who else? The city. So, in the end, everything ends up in the taxpayers’ lap.
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