Fixed-income investors returned from the holiday week with a rather defensive mindset. Although “Black Thursday/Friday” sales have been middling at best, most other economic indicators have shown surprising strength. Domestic car sales, for one, are surging, with Chrysler and GM reporting 16% and 14% gains, respectively.
Of course, we also have the November payrolls number to look forward to on Friday, although its significance may be obfuscated by seasonal factors.
After re-testing the 2.80% level yesterday, the yield on the benchmark 10-year Treasuries has retreated slightly to around 2.77% at this writing. With another Treasury auction to digest this week, we would expect the bond market to continue to trade defensively going into Friday’s employment data.
On the tax-exempt side, the demand picture has yet to improve for a 27th straight week. Outflows from muni bond funds totaled $870 million for the week of November 27th, as reported by Lipper, compared to outflows of $770 million the prior week. Long-term muni funds lost $632 million and high-yield muni funds saw $191 million go out the door.
New Issue Market
New issue volume is expected to bounce back strongly this week to about $6.5 billion, headlined by a $1.2 billion refunding from the New York Tobacco Settlement Financing Corporation (NR/AA-/AA-), a $486 million revenue issue Delaware River Port Authority (A3/A/NR) and a $370 million taxable offering from the New York State Dormitory Authority.
The NY Tobacco issue will consist of two separate series, 2013A ($662 million) and 2013B ($568 million), both on a parity but separately secured, with no cross-default provision. Retail investors will be allowed to participate in the 2013A Series, whereas the 2013B will be structured to meet institutional investors’ requirements. Although both series will be payable primarily from the State’s share of tobacco settlement monies, they will also benefit from a back-up guarantee from the State, subject to annual appropriation. This additional credit enhancement, which the offering statement claims should not be viewed as a “moral obligation” by the State (what else could it be?), led to the lofty “AA-” rating from both S&P and Fitch.
… today’s ruling by Judge Steve Rhodes has already produced a landmark decision: pension obligations should be viewed as just another set of contracts and can be restructured through the federal bankruptcy process.
From a relative value standpoint, we view the combination of a high coupon structure, short call provision and relatively wide spread as attractive for investors looking for a more defensive structure. The Series 2013A 5.00% due 6/1/22, for instance, are priced at 107.317 to yield 3.974% to maturity (+154).
All Eyes on Detroit and Illinois
Today is turning out to be a watershed day for muni investors, for a couple of reasons. First, Detroit’s eligibility to file for bankruptcy was confirmed this morning. Secondly, the Illinois legislature has also scheduled a vote today on a potential pension reform package, which we’ll discuss in more details below. Both events and their potential implications for bondholders may well set the tone for the muni market going into next year.
Detroit has now officially become the largest municipal bankruptcy in U.S. history. Needless to say, this is only the beginning of the process, not the end. Not surprisingly, the local municipal unions have already filed an appeal. Yet, today’s ruling by Judge Steve Rhodes has already produced a landmark decision: pension obligations should be viewed as just another set of contracts and can be restructured through the federal bankruptcy process. In other words, they’re not protected by state law in Chapter 9.
The Detroit ruling could ultimately impact pension reform efforts here in Illinois. As mentioned above, Illinois bondholders did receive some hopeful news over the holiday. Legislative leaders from the Land of Lincoln have reportedly reached an agreement on a pension system reform package, estimated to save $160 billion over the next 10 years. While details on the actual bill have yet to emerge, the Chicago Tribune reports that the proposal is designed to accomplish the following:
- Establish a payment plan to fully erase pension shortfall by 2044.
- Allow a retirement system to sue to force state to make required pension payment.
- Reduce public employee pension contribution by one percentage point.
- Limit future cost-of-living pension increases to 3 percent multiplied by the number of years worked times $1,000 – or $800 for those who also get Social Security. The $1,000 and $800 figures will be adjusted yearly by the rate of inflation. For example, a state employee who worked 30 years could see a $900 pension bump in year one of the plan.
- Skip some cost-of-living increases for current workers. Those 50 and older will miss one bump. Workers 43 and under will miss five bumps spread out over the years.
- Raise retirement age by up to five years for workers younger than 46.
- Create a 401(k)-style defined contribution plan that a worker can opt into instead of continuing with the state pension plan.
- Prohibit future members of nongovernmental organizations from participating in state pension systems and bans new hires from using sick or vacation time toward their pensionable salary or years of service.
Note that the current proposal doesn’t address pension relief at the local level, so Chicago’s problems are not going away anytime soon.
Given the historical lack of political fortitude on the part of Illinois legislators, a healthy dose of skepticism is certainly warranted. Nevertheless, we believe any kind of positive momentum toward pension reform will be welcome by the market. Longer-dated Illinois G.O.s have been trading around +175 vs AAA. A positive vote today could be worth as much as 25 basis points in spread tightening, in our opinion.
The bond insurers would also have much to gain, if only from an investor perception, as their exposures to Illinois and Chicago are significant, as summarized in a recent post from Mark Palmer at BTIG:
- “As of September 30, AGO had insured exposure to $24.7bn in net par outstanding to Illinois, including Chicago. This amount represents 5.2% of the company’s overall insured exposure to $473.4bn in net par outstanding (…)
- As of September 30, MBI had insured exposure to $15.5bn in net par outstanding to Illinois, including Chicago, or 5.4% of its overall insured exposure to $285.6bn in net par outstanding. Of the 50 largest credits in the company’s insured portfolio, four are related to Illinois or Chicago, including $1.421bn in exposure to Chicago’s O’Hare Airport, $1.386bn in exposure to Chicago’s GO debt and $1.303bn in exposure to Chicago’s Board of Education. MBI also had $1.147bn in exposure to Illinois Regional Transportation Authority bonds.
- As of September 30, AMBC’s listed exposures included $1.453bn in net par exposure to Chicago-related debt and $1.214bn in net par exposure to Illinois-related debt. This included $728mm in net par exposure to Chicago’s GO debt, $515mm in net par exposure to Illinois Sports Facility Authority debt and $385mm in net part exposure to State of Illinois GO debt.”
Whether or not the pension reform package gets passed, the state has already announced a $350 million taxable G.O. issue next week to meet ongoing capital funding needs. That will be the first test of the market’s reaction to this week’s proceedings.
From Detroit to Chicago, muni credit issues should remain in the headlines as we go down the home stretch for what has turned out to be quite a turbulent year.
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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