8th annual municipal market outlook call - loop capital capital... · – corporate credit spreads...

8th Annual Municipal Market Outlook Call

Chris Mier, Managing Director, Analytical Services

Presented by:

January 14, 2016 Privileged & Confidential

F


Chris Mier is the Chief Strategist and director of the firm's Analytical Services Division (ASD). The ASD has four full-time professionals.

Chris will be joined by Ivan Gulich and Rachel Barkley who will discuss certain sectors and help address your questions during the Q&A portion.

If you pre-registered for the call, a copy of the presentation was emailed to you at about 1:30 CT / 2:30 ET.

The playback will be available tomorrow through the same link as for this call.

1

Today’s Speaker


Interest rates are low.

Municipal bonds are rich.

The Fed is now tightening.

The 2016 FOMC is more hawkish.

Election year at federal, state and local levels.

Market is still waiting for “big shoes” to drop (Puerto Rico and others).

Market problems now on home turf:

– Corporate high yield bonds

– Commercial and real estate “bubble”

– Equities

Pension problems still here.

Oil price creates mounting problems for impacted states.

2

Stylized Facts

Source: Bloomberg

1,000

1,050

1,100

1,150

1,200

1,250

1,300

Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16

Small Caps (Russell 2000) 22% off Highs


Muni portfolio managers face difficult start to the new year

– Monetary policy uncertainty

– Economic uncertainty

– Domestic financial market uncertainty

– Elections

– Liquidity issues

– Credit spreads

3

Muni Performance—Review and Outlook

iShares National AMT-Free Muni Bond ETF Price ($)

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

2009 2010 2011 2012 2013 2014 2015

Muni ETF (MUB) Total Returns

CAGR 2009-2015: 5.6%

Source: Bloomberg


Sources of Total Return

– Positioning on yield curve and rolldown

– Credit ratings and spreads

– Sector selection

– Individual security selection

– Increased income flow due to higher interest rates

4

Where Does the Total Return Come From in 2016?

Comment

– Gauging the evolution of the yield curve will be difficult. The 30-yr may have completed the majority of the amount of flattening that it is going to experience.

– Corporate credit spreads may place spotlight on lack of compensation for muni credit risk.

Munis may become the most favored asset class due to risks in other domestic markets, higher yieldsand general perception of safety.


Variables included in our forecasting model:

– Local government employment

– Bond yields

– Percentage of legislatures and governorships under GOP control

– State tax receipts

– Lagged volume

5

New Issue Volume Forecast of $385 Billion

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016(F)

Long-Term Muni Issuance ($ Million)

Combined Refunding New Money

8th Annual Municipal Market Outlook Call 6

Muni Fund Flows Track Interest Rate Movements

CORRELATION BETWEEN BROAD MUTUAL FUND CATEGORIES

Money Market Funds Taxable Bonds Equities

Tax-Exempt Bonds Negative Positive None

1.00

1.50

2.00

2.50

3.00

3.50

4.00(5.00)

(4.00)

(3.00)

(2.00)

(1.00)

0.00

1.00

2.00

3.00

4.00O

ct-1

0D

ec-1

0Fe

b-11

Apr

-11

Jun-

11A

ug-1

1O

ct-1

1D

ec-1

1Fe

b-12

Apr

-12

Jun-

12A

ug-1

2O

ct-1

2D

ec-1

2Fe

b-13

Apr

-13

Jun-

13A

ug-1

3O

ct-1

3D

ec-1

3Fe

b-14

Apr

-14

Jun-

14A

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Apr

-15

Jun-

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10 Y

r A

AA

MM

D (%

) -Sc

ale

Inve

rted

Mun

i Fun

d Fl

ows (

$ B

illio

n)

Lipper Flows ($ Billion) 10-Yr AAA MMD (%)


Fed Funds Rate ForecastFed’s “dot” chart as of December 16, 2015

2015 MEMBERS OF THE FOMC 2016 MEMBERS OF THE FOMC

1 Janet Yellen Board of Governors, Chair 1 Janet Yellen Board of Governors, Chair2 William C. Dudley New York, Vice Chair 2 William C. Dudley New York, Vice Chair3 Lael Brainard Board of Governors 3 Lael Brainard Board of Governors4 Charles L. Evans Chicago 4 James Bullard St. Louis5 Stanley Fisher Board of Governors 5 Stanley Fisher Board of Governors6 Jeffrey M. Lacker Richmond 6 Esther George Kansas City7 Dennis P. Lockhart Atlanta 7 Loretta Mester Cleveland8 Jerome H. Powell Board of Governors 8 Jerome H. Powell Board of Governors9 Daniel K. Tarullo Board of Governors 9 Daniel K. Tarullo Board of Governors

10 John C. Williams San Francisco 10 Eric Rosengren Boston

Left th e FOMC New FOMC m em ber s Sou r ce: FRB

Fed median forecast

Implied by Fed fund futures


Modeling Market Evolution in 2016

METHODOLOGY

54 bps curve flattening (1-yr to 30-yr) implied by US dollar swap market

Used Fed’s Summary of Economic Projections

Built the yield curve using implied yield curve from the futures market

Backed into muni forecast using current ratios

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Current Treasury Curve

Implied Treasury Curve Dec 2016

Current Muni Curve

Forecasted Muni Curve Dec 2016


10-yr ratio lowest since Dec-2011, 13 points below ensuing average.

In 2016 ratios will overlap 2015 range, may reach levels lower than the current rich levels. Theaverage level will be higher than today’s level.

9

Muni/Treasury Ratios As a Function of Interest Rates

Interquartile Ranges for Muni / Treasury Ratios

10-Yr 30-Yr2012 11.1% 9.1%2013 6.8% 15.1%2014 4.0% 5.3%2015 4.7% 4.1%

Interquartile ranges for ratios in 2016 will likely widen compared to 2014 and 2015.

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

1.00% 1.50% 2.00% 2.50% 3.00% 3.50%

Mun

i / T

reas

ury

Rat

io

10-Yr Treasury Yield

10-YR MMD / Treasury Ratio (2012-2016 YTD)

2012

2013

2014

2015

Current85%

90%

95%

100%

105%

110%

115%

120%

125%

2.20% 2.40% 2.60% 2.80% 3.00% 3.20% 3.40% 3.60% 3.80% 4.00%

Mun

i / T

reas

ury

Rat

io

30-Yr Treasury Yield

30-YR MMD / Treasury Ratio (2012-2016 YTD)

2012

2013

2014

2015Current


Slope declined 49 bps since Q3 2015, consistent with the expectations of tighter monetary policy.

Additional flattening of 30 to 35 bps expected.

10

Slope of Municipal Curve


30-Yr M/T ratio has declined from 113% in mid-March to around 94% today.

5-yr munis outperformed 5-yr Treasuries by 17 bps since December 2014.

Muni issuance on the front end of the curve is limited due to bond series structure. Retail investorstend to favor this area of the curve, pushing muni yields and ratios down.

This has resulted in a somewhat unusual shape of the ratio curve. We expect this effect to reverseitself in 2016.

11

Muni/Treasury Curves and Ratios

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

60%

70%

80%

90%

100%

110%

120%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Yie

ld

Rat

io

Muni / Treasury Curves and Ratios (January 12, 2016)

Muni Benchmark Curve Treasury Curve

Ratio Ratio = 100%

Ratio = 110% Ratio = 90%


Munis Are Rich Across the Board

Sources: US Treasury, TM3, BEA, Freddie Mac, Merrill Lynch, Yale-Shiller

60%

80%

100%

120%

140%

160%

180%

200%

Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14 Dec-16

10-Yr Muni / Treasury Ratio

Ratio Average Linear (Ratio)

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00


20-Yr Muni - Core CPI YoY Spread

Spread Average Linear (Spread)

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%


30-Yr Mortgage Rate - Muni Spread

Spread Average Linear (Spread)

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16

10-Yr Muni / Corporate Ratio

Muni-Corporate Ratio Average

75%

125%

175%

225%

275%

325%

375%

425%

475%

525%


20-Yr Muni / S&P 500 Dividend Yield Ratio

Ratio Average

M/T ratios have dropped significantly in 2015.

Real yields are very low.

Yields have declined versus mortgage rates.

Very rich to corporate bonds.

Very rich compared to dividend paying stocks.


Since June 2014, corporate and muni spreads have moved in opposite directions.

Corporate fundamentals are eroding on a year-over-year basis.

States impacted by personal income tax, corporate income tax, sales tax and capital gains taxcollections.

13

Diverging Credit Spreads

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14 Dec-16

Credit Spreads

AAA-A 20-Yr Spread

BAML Corporate Master OAS

A divergence in muni and corporate credit spreads:

(1) Changes relative value

(2) Changes relative reward for credit risk

(3) Syphons assets away from munis

(4) Creates “transferrable” event risk from corporates to munis


Sectors and Issues


Reliance on Single Commodity

Pre-Existing

Structural Deficit

Mounting Pension Obligations

Weak Economic

Foundation

15

States Remain on Solid Ground, Despite Pockets of Pressure Event Risk: Low

KEY 2016 STATE CREDIT METRICS

• Will CA SB222 and CA Prop. 39 spark trend?

• State tax revenue structure experimentation remains a risk.

• State revenue growth is expected to slow.

Converging Credit Fault Lines Upcoming Elections

– 12 states with gubernatorial election in 2016

– AL, LA, MD, MS, NJ and VA are only states with no state-level elections

Economic Growth Still Uneven Across States

– Weakness in oil, manufacturing and trade sectors

– Auto industry is expected to remain robust

Sources of credit pressure?

– Exposure to three or four main factors (right) may lead to downward rating actions this year


Spotlight: New York Infrastructure Governor Cuomo has announced a $100B

infrastructure plan

– Spread across state, including upstate roads and NYC pathways

– LGA replaced

May lead to significant revision in debt metrics and rating changes

– Rating agencies warn of credit risk from increased capital needs by various agencies

– Needs challenge State’s recent progress in lowering above-average debt levels

$6.7B of Q1 debt planned for state, NYC and authorities

– $3.8B of new money

– 2015 issuance down 6.7% from 2014

Project Budget(in $ billions)

MTA 26

Roads and Bridges 22

Hudson Tunnel 5

LaGuardia 4

Penn Station 3

Javits Center 1

Key New York Infrastructure Projects

3.9

2.23.0

6.7

2.4

5.0

1.7

5.7

3.8

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2014Q12014Q22014Q32014Q42015Q12015Q22015Q32015Q42016Q1

Plan

ned New

Issu

ance

in Billions

New York State and Related Authorities New Money Issuance

Source: NY State Comptroller

Includes the State, New York City and their respective authorities


Local Pension Pressure Points Event Risk: High

* Examples have been selected at random. There may be other local plans with lower or similar funded levels.

Charleston, WV 8.1%

Scranton, PA 22.6%

Lincoln Park , MI 22.1%

Springfield, MA 27%

A pension-related Chapter 9 filing or conversion to a pay-go system for a city with limited debtoutstanding could raise systemic market concerns.

Several small to mid-sized cities have dangerously low funded levels, including those shown above.*

Legal structures, including pension protections, state oversight mechanisms and the ability to filefor bankruptcy, can affect the potential impact of pension obligations on bondholders.


Stable credit outlook

– The risks associated with costly capacity expansions are declining due to slow industry growth.

– Debt ratios are falling for most utilities.

Most important credit strengths

– Independent rate-making authority.

The ability to raise rates reduces the importance of traditional credit metrics (coverage, leverage and liquidity), that are, in our opinion, over-emphasized by credit agencies.

– Near monopoly provision of an essential service.

Most important consideration

– The credit quality of public power entities fundamentally depends on their ability to produce competitively priced power, while other issues are distant second in importance.

Low fuel prices will keep operating costs under control going forward.

The costs of compliance with EPA’s Clean Power Plan rules would likely create operational and financial burdens for utilities that rely on coal.

Environmental mandates and public policy are forcing utilities to invest in relatively expensive sources of power, such as wind farms.

18

Public Power Sector Outlook Event Risk: Low

“Over a quarter of U.S. coal production is now in bankruptcy, trying to reorganize to cope with prices that have fallen 50% since 2011, battered by competition from natural gas and new environmental rules.”

-The Wall Street Journal Jan. 11, 2016


Airport Sector Outlook Event Risk: Low

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3

Qua

rterly GAA

P Net P

rofit

In M

illions

Airline Quarterly Net Profits

AAL DAL UALSources: Airline Quarterly Earnings Releases

Delta Airlines plans going forward include focusing “domestically on large population centers representing rich revenue pools that can be served efficiently with larger aircraft. Internationally making investments in the most promising, high-growth geographies with strong, aligned partners and enhancing segmentation.”

-Delta Airlines Investor Day Presentation Dec. 17, 2015

Airports represent about 4% of operating expenses of major airlines.

Sector underrated by rating agencies based on default risk.

– Airlines are currently profitable and not engaging in disruptive competition.

– Airports are generally experiencing significant improvement in YoY traffic.

– Demand for air transportation is favorable, supported by employment growth, solid consumer balance sheet and low cost fares.

– Airports insulate investors from a wide variety of risks found in the G.O. sector.

– Airports are essential to long-term economic competitiveness.


Decline in Oil and Natural Gas: Credit Impacts Event Risk: High

-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%State Severance Taxes YoY Change

Texas Louisiana OklahomaSources: State Revenue Departments

-30%

-20%

-10%

0%

10%

20%

30%

40%

YoY

Cha

nge

State Monthly Revenue Collections YoY Change

Texas Louisiana Oklahoma U.S. States Aggregate

Sources: State Revenue Departments and U.S. Census

Benefits to non-producers:

– Increase in consumer spending

– MI, OH, KY, etc. benefitting since auto sales increase when fuel costs decrease

Financial impact on energy-dependent states/local credits varied due to:

– Reliance on oil and gas-related revenues to fund operations

– Economic diversification of rest of economy and % share from energy

– Pre-existing fiscal condition

Oil prices expected to remain near current levels in 2016.

Impact of removal of prohibition to export oil uncertain.


Muni portfolio managers start the year significantly disadvantaged due to:

(1) Low ratios

(2) Flatter yield curve

(3) Low interest rates

Greater policy uncertainty due to wider range of possible paths.

Major credit and sector issues remain unresolved.

Like currency, commodity and global markets, domestic financial markets have become unsettled.

Muni bonds may increase their importance as a favored asset class

with AUM growing at the expense of other product markets.

21

Conclusions—No Shortage of Challenges in 2016


Loop Economic and Interest Rate Forecast

3Q’14 4Q’14 1Q’15 2Q’15 3Q’15 4Q’15 1Q’16 2Q’16 3Q’16 4Q’16 1Q’17 2Q’17 A v g'15 A v g'16 A v g'17**

Econ om ic Foreca st s

Rea l GDP 4.3 2.1 0.6 3.9 2.0 2.1 2.6 2.6 2.5 2.7 2.5 2.4 2.2 2.6 2.5

Cor e PCE Pr ice* 1.6 1.4 1.3 1.3 1.3 1.5 1.7 1.7 1.7 1.8 1.8 1.8 1.4 1.7 1.8

Un em ploy m en t Ra te* 6.1 5.7 5.6 5.4 5.2 5.0 4.9 4.9 4.8 4.7 4.6 4.6 5.3 4.8 4.6

Non fa r m Pa y r olls (ch g in 1 000s) 712 973 586 692 521 709 575 550 550 540 530 520 2,508 2,215 2,100

S&P 5 00 1,976 2,009 2,064 2,102 2,027 2,052 2,083 2,114 2,146 2,178 2,211 2,244 2,061 2,130 2,227

Sh ort -T erm In t erest Ra t es*

Fed Fu n ds Ta r g et (%) 0.09 0.09 0.11 0.13 0.14 0.16 0.56 0.80 0.90 1.17 1.42 1.63 0.13 0.86 1.53

3 -Mon th LIBOR (%) 0.23 0.24 0.26 0.28 0.31 0.41 0.74 0.98 1.08 1.35 1.60 1.81 0.32 1.04 1.71

7 -Da y SIFMA (%) 0.05 0.04 0.02 0.08 0.03 0.02 0.10 0.20 0.30 0.40 0.50 0.60 0.04 0.25 0.55

T rea su ry In t erest Ra t es*

2 -Yea r Tr ea su r y (%) 0.50 0.52 0.59 0.60 0.68 0.82 1.11 1.27 1.37 1.55 1.75 1.98 0.67 1.32 1.87

3 -Yea r Tr ea su r y (%) 0.97 0.95 0.96 0.96 1.01 1.13 1.34 1.50 1.58 1.76 1.99 2.20 1.02 1.55 2.10

5 -Yea r Tr ea su r y (%) 1.69 1.59 1.45 1.52 1.55 1.58 1.72 1.88 1.93 2.10 2.36 2.55 1.53 1.91 2.46

7 -Yea r Tr ea su r y (%) 2.15 1.99 1.77 1.91 1.94 1.94 2.01 2.16 2.20 2.36 2.61 2.78 1.89 2.18 2.70

1 0-Yea r Tr ea su r y (%) 2.49 2.27 1.96 2.16 2.22 2.18 2.32 2.45 2.48 2.62 2.75 3.00 2.13 2.47 2.88

3 0-Yea r Tr esu r y (%) 3.26 2.96 2.55 2.89 2.96 2.96 3.01 3.06 3.11 3.15 3.20 3.25 2.84 3.08 3.23

Mu n icipa l In t erest Ra t es*

3 0-Yea r MMD (%) 3.41 2.98 2.77 3.12 3.15 3.00 2.87 2.87 2.89 2.99 3.08 3.19 3.01 2.91 3.13

Mu n i Yield Cu r v e Slope (%) 3.36 2.83 2.62 2.89 2.89 2.67 2.43 2.29 2.24 2.18 2.12 2.10 2.77 2.28 2.11

* 3 m on th a v er a g e

Sou r ce: Loop Ca pita l Ma r kets' A n a ly t ica l Ser v ices Div ision . Bla ck Tex t : A ctu a l, Blu e Tex t: For eca st a s of 1 2 /2 3 /1 5


Analytical Services Division ([email protected])

23

Thank you for listening!


Disclaimer

24

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8th annual municipal market outlook call - loop capital capital... · – corporate credit spreads...

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