Market Outlook
It’s Election Day and voters around the country will have a say on some key issues with potential impact on municipal creditworthiness. Two gubernatorial elections, in New Jersey and Virginia, will be closely watched by media pundits for their potential impact on the national political agenda. City halls in some major metropolitan areas will get new occupants, most notably in New York City, Boston and yes, Detroit. As noted by our fellow analyst, Natalie Cohen from Wells Fargo, in a recent report, pension reform initiatives are also becoming more common. The most significant include Cincinnati’s proposed charter amendment to replace the city’s defined benefit plan with a defined contribution plan and the California Pension Reform Initiative, which actually won’t hit the ballot until 2014.
Puerto Rico bondholders have the right to be a little confused this week. On the one hand, the Puerto Rico Planning Board announced that it was revising its projected growth of gross national product for FY2014 to -0.8%, down from a positive 0.2% previously. This would be consistent with the recent monthly economic indicators coming out of the GDB. However, Treasurer Melba Acosta Febo also announced yesterday that preliminary revenues for October were up by $262 million versus last year, and $110 million above budget. The sales and use tax, which is partially pledged to Cofina bonds, also registered a 9.7% rise year-over-year, but actually fell short of projections.
Puerto Rico bondholders have the right to be a little confused this week.
We don’t really view these two reports as contradicting each other. Much of the reported revenue growth has come from new revenue measures (higher tax rates and new taxes), not from growth in the underlying economy. In fact, the numbers show that the tax burden continues to shift from individuals to corporations. Personal tax collections are off 25% year-over-year and 14% short of projections. Could this be reflective of ongoing out-migration and poor labor force participation?
While balancing the budget on the back of corporations may be a necessary evil to address the fiscal crisis in the short term, we’ve always contended that such policy will end up hurting the PR economy in the long run. Interestingly, excise tax collections on foreign corporations subject to Act 154 also dropped by $21.5 million year-over-year: according to the Treasury, this “is attributable to the actions of one company to accelerate certain purchases of merchandise related to certain planning initiatives on its distribution chain last year.” As can be expected, corporate taxpayers are already devising strategies to reduce their tax liabilities under the new tax regime.
We’re looking forward to a vigorous debate on these very same topics at tomorrow’s Bloomberg State & Municipal Finance Conference in New York City.
New Issue Market
This week’s new issue calendar should come in at just under $6 billion, up from $5 billion last week. The anchor issue on the negotiated calendar will be an $807 million G.O. offering from the State of Hawaii. You may recall that Hawaii’s pension system ranks among the worst-funded in the nation, with a funded ratio of 59.2% and an UAAL (Unfunded Accrued Actuarial Liability) per capita of $6,329, according to a recent study by Morningstar. There’s been much hand-wringing among muni professionals about pension funding issues but until now, except for extreme cases such as Illinois, Chicago and Puerto Rico, one would be hard pressed to see any real impact on trading levels. In Hawaii’s case, the 2033 term maturity was priced yesterday at 4.16% to maturity or about +47 to the MMD AAA scale. Even though Hawaii always trade cheap to its Aa2/AA/AA rating, you could say there was a modest market penalty of about 10 basis points.
The next largest negotiated deal is potentially more interesting as it portends a little resurgence in high yield supply: the New Jersey Economic Development Authority will be bringing $438 million in private activity bonds to build a replacement for the obsolete Goethals Bridge, which connects Elizabeth, New Jersey to Staten Island. This is a public-private partnership between the Port Authority of New York & New Jersey and units of Macquarie Infrastructure and Kiewit Development, both highly reputable firms. The bonds are rated BBB-minus by both S&P and Fitch, primarily based on construction risk.
… the high yield [municipal bond] calendar does appear to be building up with some sizeable issues on the horizon.
The two longest maturities in 2043 and 2052 are currently priced at yields-to-maturity of 5.70% (+164) and 5.95% (+189), respectively. We believe the proposed spreads do provide reasonable relative value, particularly for double tax-exempt New Jersey paper (although subject to federal Alternative Minimum Tax). The 2043 maturity is also available with Assured Guaranty insurance, to yield 5.45% or (+139). Given the relatively weak underlying rating of BBB-minus, and the upfront construction risk, we would lean toward the AGM-insured and forgo the extra 25 basis points in yield. Of course, others may argue that, since interest is capitalized from bond proceeds over the rather long four year construction period, why not just earn the extra yield from the uninsured piece for virtually little additional risk? We leave that to your judgment.
Away from the Goethals deal, the high yield calendar does appear to be building up with some sizeable issues on the horizon.
Also in the Garden State, the Meadowlands/Xanadu project is being revived yet again, with a new developer (Triple Five, known for the Mall of America in Minnesota) leading the charge to revive this floundering, long-delayed East Rutherford, New Jersey retail mall/entertainment complex project. According to local news sources, there is a new push to complete the project before Superbowl 2014 at the Meadowlands.
This potential $748 million high yield issue will require the cooperation of several state and local governmental entities. Last week, the New Jersey Economic Development Board approved a $390 million tax break for the developer and the New Jersey Local Finance Board gave the green light to issuing its share of the bonds. The Bergen County Improvement Authority and the East Rutherford borough council still have to give final approval for the project. Goldman Sachs has been selected as underwriter of the deal and hopes to bring the issue to market before year end.
Last but certainly not least, the infamous Jefferson County, Alabama will attempt to sell, perhaps as early as this week, $1.723 billion of new refunding sewer warrants as part of its plan to exit Chapter 9. If you recall, the County’s original plan to issue new refunding warrants to defease $3.2 billion of outstanding debt was derailed by the sharp rise in tax-exempt rates over the summer. The County had to go back and negotiate an additional $350 million in concessions from creditors, on top of the $1.3 billion haircut already negotiated. This time around, given the potential for further market volatility, the County made the unusual decision to sell bonds before exiting bankruptcy. Frankly, we can’t think of another instance of bankrupt muni entities selling bonds prior to wrapping up their Chapter 9 proceedings. Arguably, in this case, a successful refunding is in itself a key component of the reorganization plan. We’ll wait to see more details about the bond issue before making further comments.
All in all, high yield muni investors should have a few deals to nibble on between now and year end.
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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