Supply Volumes Set to Rise While Demand Dwindles
Issuers of municipal bonds may enter the primary market in increasing numbers, amid continued ultra-low U.S. interest rates and ongoing healthy demand.
A host of new muni offerings are set to cross the wires, with more than US$12.65bn worth of new supply eyed in the Bond Buyer’s 30-day Visible Supply, up US$711m over the prior week.
While fixed-income investors generally continue to be drawn to the yield offered by new muni issuance, and although interest may rise further amid newly proposed regulatory capital requirements, some market participants foresee a technical shift in market dynamics.
Nuveen analysts Bill Martin and John Miller recently observed that the municipal bond market is reversing the supply and demand dynamic in place this year. They noted that while supply is expected to increase, with issuers seeking historically low borrowing rates, demand “should be tempered, as monthly bond calls will be less than the record call pace seen in each month of 2019.”
Indeed, demand among muni bond investors has been dwindling in recent weeks.
For the week ended September 4, Thomson Reuters/Lipper U.S. Fund Flows posted net inflows into muni bond funds of more than US$775m, down from around US$1.24bn in the prior week, and following a gradual reduction of inflows over the previous three weeks, which totaled roughly US$1.35bn, US$1.5bn and US$2.07bn, respectively.
While these flows do not include exchange-traded funds (ETFs) such as the iShares National Muni Bond fund (NYSEARCA: MUB) and the Vanguard Tax-Exempt Bond fund (NYSEARCA: VTEB), prices of those ETFs have also been falling – now having gained around 9.67% and south of 7.8%, respectively, since their most recent 52-week lows in early November 2018.
Nuveen’s Martin and Miller added they expect the trend of higher supply and moderating demand to continue, however the “strong” U.S. Treasury market means “we would view any municipal market sell offs as a potential buying opportunity.”
The yield on the 10-year U.S. Treasury note climbed to around 1.625% intraday Monday, amid a more positive risk-taking tone, as escalating U.S.-China trade tensions eased somewhat, and as market participants focus on widely expected dovish monetary policy decisions by the European Central Bank (ECB) later in the week, followed by the Federal Reserve’s Open Market Committee in the following week.
Against this backdrop, the 10-year muni / U.S. Treasury ratio last stood at around 84%, with munis having returned around 7.44% year-to-date, underperforming that of U.S. Treasuries (8.40%), according to the Bloomberg / Barclays Index.
Supply High …
Meanwhile, other analysts agree that municipal bond supply is likely to see a lift over the near-term, as borrowers generally reap the benefits of low-cost funding.
Barclays strategists, for example, noted that they expect new issuance to rise over the next few months, with both refunding and new money deals likely picking up. They pointed out that August’s supply level was higher than the average for the past five years, bringing year-to-date issuance to US$238bn, an increase of 5% over the prior year.
While August marked the highest volume of new issuance year-to-date in 2019, supply in September could well surpass that level, with more than US$8bn offered last week and over US$10bn set to price in the week ahead.
… and for Higher Ed
Among the transactions slated to be sold, Rutgers, the State University of New Jersey, is on the radar with US$330m worth of 100-year, federally taxable general obligation bonds, 2019 Series P.
The school intends to apply proceeds from the century bond sale primarily towards the financing and / or refinancing of various capital projects approved by its Board of Governors.
In June 2015, Rutgers completed its Physical Master Plan, Rutgers 2030, which maps out the university’s development over a 15-year period, including its buildings, landscape, transportation and infrastructure. Projects underway as part of this plan have been funded by a combination of the school’s private donors, funds made available by the state, university bond funds, and by creative partnerships with the public sector.
Major construction projects completed or in progress include:
Construction of a 57,000 square foot addition to the existing William Levine Hall Building for the School of Pharmacy; New construction of a 104,000 square foot facility for the Richard Weeks Hall of Engineering; Construction of a 10,500 square feet at the Waksman Institute of Microbiology on the Busch Campus; and a 125,000 square foot facility at RWJ Barnabas Health Athletic Performance Center at Livingston Campus.
Grade ‘A’ / ‘AA’
S&P rated the offering an investment-grade ‘A+’, while Moody’s Investors Service assigned an ‘Aa3’ credit rating on the bonds, with a stable outlook.
Moody’s analysts Susan Shaffer and Susan Fitzgerald noted that they based their stable outlook on “expectations of continued generally breakeven operations,” while also considering that the university’s financial reserves will likely not deteriorate, that it will “maintain the ability to absorb some reductions in state and federal funding or fluctuation in healthcare-related revenue, and that debt will not increase materially without offsetting operating cash flow and financial reserve growth.”
Overall, Rutgers had around US$2bn in debt outstanding as of June 30, 2019, with various interest rate swap arrangements in place.
However, Moody’s warned that the school has thin unrestricted financial reserves compared to its operating expenses and high debt, as well as “the increasingly pressured state environment, including long-term pension pressure.” Moreover, Rutgers’ “ambitious multi-campus capital plan requires significant capital investment,” and its affiliation with RWJ Barnabas “adds moderate risk due to higher volatility associated with the healthcare sector.”
As part of a 20-year agreement, RWJ Barnabas Health provided Rutgers with an initial investment of US$100m in FY2019 and is expected to provide up to US$50m annually over a 10-year period, with up to US$1bn anticipated over 10 years.
Moody’s added that growing enrollment and health care-related revenue contribute to Rutgers’ diversity of revenue streams and, combined with expense containment and completion of almost all union agreements, are expected to modestly improve operating performance in fiscal 2019 and 2020 after weaker fiscal 2018 performance.
In terms of rankings, Rutgers has been named by U.S. News & World Report as the number one Public University in New Jersey, and in the Northeast, as well as the top 25 Public University in the Nation.
The bond, which matures May 1, 2119, is being co-lead managed by Morgan Stanley and Barclays, and is scheduled to price September 11.
Disclosure: Interactive Brokers
The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Disclosure: Author Security Holding: No Positions
The author does not hold any positions in the financial instruments referenced in the materials provided.