The year began with a significant amount of market uncertainty, with many market participants anticipating impending market-wide turmoil. However, contrary to many consensus forecasts, the market saw strong overall performance. Heading into 2020 there appears to be more optimism, but unfortunately, still some uncertainty.
The 2019 milestones laid out in the original Paced Transition Plan released by the Alternative Reference Rate Committee (“ARRC”) regarding the transition from LIBOR to SOFR were accomplished ahead of schedule. Incremental objectives are tracked by the ARRC at https://www.newyorkfed.org/arrc/sofr-transition. Of note, throughout 2019 the ARRC released recommended fallback language for cash products, while managing to increase market liquidity of SOFR denominated products. Nevertheless, SOFR did experience hiccups along the way. Two occurrences which sparked concern throughout the year were “turn”, and the “SOFR Surge Event” which occurred in September. Both events involve(d) significant overnight spikes in SOFR, an issue that participants will continue to grapple with as the transition to SOFR picks up pace, though it’s believed that the effects of these spikes will be limited in instruments referencing SOFR due to averaging.
A major milestone for the LIBOR transition in 2020 is that by the end of the year swap central counterparties (CCP’s) are anticipated to begin discounting their swaps with SOFR. This action will significantly increase liquidity, while continuing to boost the legitimacy of the rate. Also, ISDA is expected to publish an amendment to fallback methodology, on which it collected feedback in 2019.
The broad market consensus heading into 2019 was that interest rates were expected to continue to climb. However, this trend reversed over the past year as a result of several market-wide factors including trade and geopolitical tensions, a weakening global economic outlook, and stagnant domestic inflation. The result has been significant flattening and even periodic inversion of several market benchmark yield curves, in addition to a lower overall rate environment. This topic was covered in our June newsletter [https://www.blueroseadvisors.com/post/june-2019-municipal-market-update]
Since that newsletter was published, the market has trended in a similar direction. Over the past two weeks though, there have been a couple of positive market events which have slowed falling bond rates. These events include the: cooling of trade tensions between the US and China (sparked by a preliminary phase 1 trade agreement), and the Fed signaling that it will maintain its benchmark rate range at 1.5% to 1.75% throughout 2020, illustrating its belief that the economy is better positioned than it had been leading up to its last three consecutive rate cuts.
The recent rate environment has resulted in an increase in popularity of both taxable advance refunding and forward refunding transactions. Both options for borrowers to capture refinancing savings were aided by multiple recent market trends, the most significant being the low overall interest rates prevailing in the market throughout most of 2019. Additionally, the viability of taxable advance refundings increased as a result of a decrease in the spread between taxable and tax-exempt rates, while flattening yield curves and low forward premiums led many other issuers and borrowers to utilize tax-exempt, forward settling refunding transactions to generate refunding savings in both the public and private markets. Both have picked up momentum towards the end of the year, enabling borrowers to lock in savings more than 90 days ahead of the call dates of their outstanding bonds and providing viable alternatives to tax-exempt advance refundings, which were eliminated as an option for municipal issuers after 2017 tax reform.
As expected, revenue remained constrained throughout 2019 in the higher education industry. Declines in demographics have been the most significant contributing factor to this constriction, with a particularly potent impact in the Midwest, and Northeast, as well as broadly across private higher education. Tuition discounting and pricing are expected to remain a challenge into 2020. However, Moody’s recently revised their outlook on the US Higher Education market from negative to stable, a positive development to end 2019. The primary drivers of this outlook change include improved health of balance sheets, a growth in unrestricted liquidity, declining levels of debt, and an anticipation of steady revenue streams outside of tuition.
The US economy is currently in one of the longest continuous expansions in history, which naturally has many market participants concerned about a downturn. As mentioned earlier, the economy didn’t experience that downturn in 2019; rather, it continued its expansion despite market volatility and uncertainty. Currently, the primary threats to this growth are political in nature and include: the 2020 U.S. presidential election, impeachment proceedings, the Brexit vote, Hong Kong elections, and trade disputes. The outcomes and impact of these events remain unquantifiable, so as they continue to unfold it will be important to monitor and assess their future developments and the resulting effects on the market going forward.
As these topics gained popularity throughout the year, our newsletters covered many in more depth, in addition to other salient municipal market topics not covered in this article. Follow the link for access to past newsletters [https://www.blueroseadvisors.com/blog].
 “Turn” in this case refers to the tendency of the repo market (which underlies SOFR) to experience abnormally high levels of activity at month and quarter-end.
About the Author
Brandon Lippold, Associate: Brandon Lippold joined Blue Rose in 2018, providing modeling, analytics, market data and research in support of the delivery of capital planning, debt and derivatives advisory, and reinvestment services to our clients.
Mr. Lippold holds a bachelor's degree in financial management from the University of St. Thomas, and is a member of their chapter of the Delta Epsilon Sigma honors society. Mr. Lippold passed the MSRB Series 50 Examination to become a qualified municipal advisor representative and is currently pursuing his Chartered Alternative Investment Analyst (CAIA) designation for which he has passed the level 1 exam.
Brandon can be reached at email@example.com
Comparable Issues Commentary
Shown below are the results of two negotiated, tax-exempt higher education issues that sold in late November and early December. Michigan State University (“MSU”) and Oregon Health and Science University (“OHSU) priced their Series 2019C and Series 2019A bonds, respectively, on November 26th and December 5th. The deals were sized similarly, with both ranging between $125M and $150M in par amount. However, OHSU also priced three other series concurrent with its 2019A issue – its 2019B-1 and 2019-B2 bonds, sold as tax-exempt bonds with mandatory repurchase dates in 2023 and 2025, as well as its taxable 2019C bonds. These three issues combined slightly exceeded OHSU’s 2019A bonds in total par amount, but were all sold utilizing different financing structures than the standard tax-exempt, long-term committed fixed rate approach used for its 2019A bonds.
Michigan State’s deal was rated Aa2/AA by Moody’s and S&P, respectively, while OHSU’s bonds were rated Aa3/AA-/AA- by Moody’s, S&P, and Fitch. MSU’s bonds were purely issued for refunding purposes, serving to currently refund the University’s 2010C bonds for interest rate savings. OHSU’s deal also carried significant refunding components, with the 2019A and 2019B bonds combining to refinance outstanding series including the 2012B-3, 2012C, 2015A, and 2015B bonds of the University. Additionally, the University’s taxable 2019C bonds, in conjunction with a direct placement with JPMorgan Chase, served to advance refund a portion of the University’s 2012E bonds. The 2019A bonds also financed other projects besides refundings of outstanding debt, however, with approximately $35M of new money issued to fund the acquisition of the Physicians Pavilion building on OHSU’s main campus and another ~$24M issued to finance a tender offer made by the University to repurchase a portion of its 2012E bonds.
Both deals sold on fairly stable days in the market, with MMD reduced by 2-3 bps across the curve (2 bps through 2028 and 3 bps thereafter) for Michigan State’s sale on the 26th and reduced on the 5th by 0-1 bps across the curve (unchanged through 2026 and -1 bp thereafter) on the day of OHSU’s pricing. Notably, Michigan State’s 2019C bonds were sold with semiannual maturities across parts of the yield curve, matching the structure of the 2010C bonds they refinanced. The two universities utilized similar call and couponing structures for their transactions, with each pricing bonds using a standard 10-year par call option and both selling 5% premium callable coupons through 2037 before using lower 4% coupons thereafter in 2038-2039 as well as for their 2044 term bonds. OHSU’s deal, with a final maturity 5 years longer (2049) also sold an even lower 3% discount coupon for its 2049 term bond. On the longest-dated callable 5% coupon maturities, MSU’s bonds sold at spreads of +28 bps above AAA MMD while OHSU’s bonds priced at spreads of +37-39 bps. Michigan State’s callable 4% coupon maturities priced at spreads of +56-57 bps, compared to spreads of +66-67 bps for OHSU.
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