By: Brandon Lippold, Associate
Since we published our 2019 Municipal Market Year in Review market update in December, the financial markets have experienced historic turbulence with the onset of the COVID-19 pandemic. As a response to this turbulence, Blue Rose has begun publishing weekly “Special Editions” of The Shield to address key municipal market topics as they develop. This article takes a step back from these focused issues to address the general condition of the municipal market today – however, many of these past salient topics are summarized briefly as part of this article, with links included to some of our past pieces discussing them in greater detail.
Obviously, the primary market mover in 2020 has been the COVID-19 pandemic. The April edition of The Shield touched on some of the initial market impact and sentiment following the broad spread of the virus in March. Overall, absolute interest rates remain low, providing an attractive borrowing environment complicated by increased risk premiums resulting from COVID-related fears. Some other significant factors which have impacted or are anticipated to impact the general market in the coming months include the following:
· expanded quantitative easing programs
· continued trade tensions with China
· geopolitical tensions
· the upcoming presidential election
· potential future waves of COVID-19
Over the past year MMD has shifted downward by approximately 100 bps. However, in the immediate aftermath of the recent pandemic this index saw significant volatility. A look back at the March 20 MMD yield curve displays this well, with rates shifting upward by more than 200 bps above current levels. This significant momentary spike in March MMD rates is very evident when looking at a 5-year history of 5, 10, & 30-year AAA MMD (see the chart below), with those rates approaching recent historical highs, although the index has since begun to stabilize with the gradual rebound of the market in May and June.
During the same period MMD was experiencing historic shocks, the LIBOR swap curve saw a much more modest adjustment. The LIBOR market remains near historic lows, albeit with some slight steepening resulting from the COVID-19 pandemic with an inflection point around the 15-year point on the curve.
The Fed’s overnight target rate fell off a cliff as part of its response to the COVID-19 pandemic, with a target range of 0%-0.25% announced in early March. Comparing recent forecasts to those from last June, you can see this total reversal in the rate strategy and projections for its future growth/reduction. The Fed has indicated that it does not plan to target rate hikes in the foreseeable future, with the expectation being to maintain its current target range until 2022.
The SIFMA/LIBOR relationship has remained volatile, and briefly became dramatically dislocated at the beginning of the pandemic (with SIFMA spiking to above 5% while LIBOR remained low), though rates have normalized as a result of Fed action to stabilize the VRDB market since the initial March shock. Both indices have since fallen to very low levels (below 0.25%). Our May Basis Points Special Edition article touched on the basis risk between these two indices highlighted by the severe dislocation between them in March, as well as potential actions that issuers could take to mitigate this risk in the current market.
Paycheck Protection Program
Government stimulus played a major role over the last few months with the economy struggling to respond to a shutdown of public spaces. The CARES ACT was the primary source of stimulus for small business and non-profit institutions over this period - see our Special Edition of The Shield from April, which touched on the PPP portion of this program as it kicked off, for additional information. Since then, there have been several significant clarifications/changes to the PPP including but not limited to:
· 24-week disbursement period
· 60% of funds must be used for payroll
· have until December 31, 2020 to restore salary/hourly wage/FTE reductions
· extension of the deferral of loan payments
· more flexibility in the maturity of the loan
· likely $2MM review exemption.
The PPP loan application window closed on June 30, 2020 with $130 billion remaining unspent. However, soon after this window closed the Senate and House voted to approve a 5-week extension, meaning borrowers now have until to August 8th to apply.
Credit Rating Agency Actions
Recently rating agencies have moved to adjust their view of the higher education sector as a response to the COVID-19 pandemic. The sector now has a “Negative” outlook across the three major rating agencies, with Moody’s adjusting its outlook downward in response to the crisis while S&P and Fitch maintained their already-negative outlooks. Thus far, a limited number of downgrades have occurred as the rating agencies wait to assess FY20 results and uncertainty remains about how Fall 2020 will look for higher education institutions. Our June Shield article covers this topic in further detail.
The LIBOR transition process continues while milestones set by the ARRC (Alternative Reference Rate Committee) continue to be met on time (https://www.newyorkfed.org/arrc/sofr-transition#pacedtransition). The best practice for institutions entering into agreements with LIBOR exposure remains focused on fallback/waterfall language. The plan remains that Banks will no longer be obligated to make LIBOR submissions after December 31, 2021. The ARRC continues to publish major updates on its website (https://www.newyorkfed.org/arrc/sofr-transition#progress).
About the Author:
About the Author
Associate | email@example.com
Brandon Lippold joined Blue Rose in 2018 as a Quantitative Analyst, 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. Now in the role of Associate, he utilizes his experience as a Quantitative Analyst in a more client-facing role, while still performing much of the analysis utilized in this capacity.
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 also is currently pursuing his Chartered Alternative Investment Analyst (CAIA) designation, for which he has passed the level 1 exam.
Comparable Issues Commentary
Shown below are the results of two negotiated, tax-exempt public higher education issues that sold in the month of June. Miami University (“Miami”) and Virginia Commonwealth University (“VCU”) priced tax-exempt bond issues on June 16th and June 11th, respectively. Miami’s tax-exempt issuance was significantly larger than VCU’s 2020A bond issue ($128.47M vs. $25.315M, respectively), but VCU’s plan of finance also included a larger 2020B taxable issuance of $71.565M. Additionally, Miami’s transaction included sizable borrowing for two new money projects – the financing of a new health sciences building and a new digital innovation multidisciplinary building – in addition to a smaller current refunding component. In contrast, VCU’s bond issues were each entirely utilized to either refund outstanding bond issues or refinance projects financed on an interim basis into longer-term debt. Miami’s bonds were rated Aa3/AA (Moody’s/Fitch), while VCU’s bonds were rated Aa3/AA- (Moody’s/S&P).
Both institutions were able to take advantage of increased stabilization in the municipal market during early and mid-June. During this time tax-exempt rates remained fairly stable while credit spreads continued to gradually tighten following the extreme widening provoked by the COVID-19 pandemic (though spreads still remained wider than pre-pandemic levels). On June 11th, VCU priced its bonds on a favorable, though somewhat volatile, market day, with MMD increasing by 1-2 bps on the short end of the curve (2021-2023) but decreasing by 1-5 bps over the later years of VCU’s tax-exempt maturity spectrum (2026-2033) and even more (6-7 bps) further out on the curve from 2037-2050. Miami sold its Series 2020A bonds a few days later on June 16th, entering a slightly choppier market (where Treasuries yields were up and MMD would reset up by 1-2 bps across the entirety of the yield curve), but still priced favorably, with strong demand, particularly earlier on the yield curve (2021-2032 maturities), leading to yield reductions of 0-8 bps during repricing. Both issuers utilized a standard 10-year call option, and each also opted for a degree of coupon diversification. VCU utilized both 3% and 5% coupons on its noncallable maturities as well as a pair of callable 4% maturities in 2031 and 2032, while Miami opted for 5% coupons through 2036 before shifting to 4% coupons thereafter (and also bifurcating the 2036 maturity to include both 4% and 5% coupons). Miami’s bonds were sold with a 25-year final maturity in 2045, while VCU’s 2020A bonds had a shorter 13-year final maturity in 2033.