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By Erik Kelly
Summary
In Minnesota, spring weather is typically rather erratic. This has been evidenced once again in 2020, which has made me ponder the similarities of this year’s weather to the recent tax-exempt market behaviors. No, I’m not suggesting the two are correlated, although I wouldn’t be the first to make this claim as theories exist that investor behavior is impacted by one’s mood which is impacted by the weather. But theories aside, I’m simply fascinated by the quickly changing dynamics that have permeated the markets over the last two months and how those changes feel, well, like the weather. This unpredictability, of course, makes it all the more difficult to navigate these markets and determine the most appropriate actions for one’s institution. Allow me to draw some comparisons.
Observations
Tax-exempt capital market behaviors consistent with an early April snowstorm (i.e., not so good):
Between March 10-20, the 10-year tax-exempt fixed rate benchmark index (MMD) increasing by 201 bps.
SIFMA trading in a 500-bp range over the course of a month.
- Even worse, individual VRDBs trading significantly higher than the SIFMA index over that same period.
Multiple instances of a meaningful 10+ basis point increase to the tax-exempt benchmark index (MMD) on days when taxable rates declined, including this week on April 28th.
Inflated tax-exempt to taxable ratios that indicate tax-exemption is not obtaining its true value.
- 10-year tax-exempt to taxable ratio is currently at 228%.
Tax-exempt capital market behaviors consistent with a 50-degree, cloudy day (i.e., about average):
Some secondary trading activity leading to market stability but no changes to benchmark indices, such as occurred yesterday on April 30th.
Tax-exempt capital market behaviors consistent with a 70-degree, sunny day (i.e., these make me happy):
Between March 24-30, the 10-year MMD decreasing by 155 bps.
Meaningful (10+ basis point) one day declines in the benchmark index (MMD) occurring in late March and early April.
SIFMA resets approaching their taxable index counterparts.
- As of April 30th - SIFMA at 0.21% vs. effective Fed Funds rate at 0.04%.
The following charts reflect the erratic trading patterns described above.
Advocacy and, Hopefully, Sunnier Days Ahead
The Blue Rose team is pleased to be a strong advocate for our clients. At all times, but especially when the markets demonstrate volatility, unusual trading patterns, or unreasonable value – including the market environments that have arisen over the last two months – Blue Rose advisors will search for an optimized transaction structure, an alternative market or investor base, and more opportune times to execute a financing.
While advocacy measures most often arise at or near the time of pricing a transaction, Blue Rose’s advocacy goes well beyond an individual transaction. Over the last two years and especially now, we have been advocating in Washington for the re-implementation of financing tools that will provide greater flexibility and savings to tax-exempt issuers and borrowers. Most notably, the elimination of tax-exempt advance refundings through The Tax Cuts and Jobs Act of 2017 has caused municipal issuers to consider and execute various alternative refunding structures ahead of a bond issue’s call date. Structures include, but are not limited to, taxable advance refundings, tax-exempt forward delivery bonds, “Cinderella” conversion bonds, and forward starting interest rate swaps. Now, however, with the current pandemic leading to the need for economic stimulus, Congress is considering various funding and policy changes to benefit the public finance market. We, along with many others, continue to advocate for the return of the tax-exempt refunding alternative to provide borrowing flexibility and savings to both governmental entities and not-for-profit institutions across the country.
Here’s to sunnier and happier spring days in the tax-exempt capital markets. Cheers!
About the Author:
Erik Kelly President | ekelly@blueroseadvisors.com Erik Kelly serves as President of Blue Rose, providing leadership, coordination, and oversight of the firm’s advisory services since 2011. He also serves as the lead advisor to many of the firm’s clients, including advising higher education entities on the planning for and execution of all types of debt and debt-related derivative transactions. In managing the firm’s various advisory service areas, Mr. Kelly oversees both compliance with the changing regulatory environment and the delivery of professional advice to the firm’s clients. Education
Mr. Kelly holds a bachelor’s degree in economics from Amherst College and a master’s degree in theological studies from Bethel University. Mr. Kelly is a Series 50 qualified municipal advisor representative and Series 54 qualified municipal advisor principal.
Comparable Issues Commentary
Shown below are the results of two negotiated, tax-exempt public higher education issues that sold in the month of April. Arizona State University (“ASU”) and Oklahoma State University (“OSU”) each priced their Series 2020B bond issues on April 14th. Both universities issued their deals as part of a broader plan of finance, with each school selling a larger tax-exempt 2020A series as well as a taxable 2020C series on the same date as the 2020B issues. The two 2020B series were both entirely new money issues, with no refunding components included. Oklahoma State’s 2020A and 2020C issuances were, however, almost entirely used for refinancing outstanding bonds, while none of Arizona State’s three bond series carried any refunding components. Arizona State’s bonds were rated Aa2/AA (Moody’s/S&P), while Oklahoma State’s bonds carried ratings one notch lower at AA-/AA- (S&P/Fitch).
Despite the substantial volatility the municipal market has experienced recently with regard to credit spreads and absolute rates on both tax-exempt and taxable issues, it appears the bond sales of ASU and OSU were timed quite well. April 14th, the day both universities priced their deals, was the last in a streak of 7 straight business days of MMD reductions across the yield curve. Over that stretch, MMD rates fell anywhere from 43-79 bps depending on tenor, a substantial rebound from their spike in late March, and ultimately a “nadir” during the crisis given the gradual rate increase across the MMD curve that has occurred in the second half of the month. Credit spreads for both transactions were fairly stable as well given the market volatility, with callable 5% coupons pricing at spreads of 30-31 bps for ASU and 43-45 bps for OSU.
Both transactions were fully serialized through 2040, with term bonds utilized over the remaining 10 years leading up to their final maturities in 2050. The issues did differ slightly in coupon structure, with Arizona State predominantly using 5% coupons on its callable maturities until its final two terms in 2047 and 2050, while Oklahoma State used 4% coupons much more heavily from 2036-2045, along with a 3% par coupon in its 2050 term maturity. Both series were sold with a standard 10-year par call option. Oklahoma State’s 2020B bonds were structured for level debt service over 30 years, while Arizona State’s 2020B issuance was structured for level debt service over a 20-year period at just over $2M/year before stepping down to just over $1M/year for the final 10 years of maturities.
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