Muni Market Update (June 5th, 2017): Illinois Nears Junk Status

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Muni Market Update

Muni Market Update

The biggest news last week was Illinois’ downgrades by S&P and Moody’s to BBB- and Baa3 respectively. This puts the state’s GO rating just one notch away from junk status. This is the lowest rating for a state GO in recent history and makes Illinois the lowest rated state in the country.

From Moody’s report:

The downgrade to Baa3 for Illinois’ GO bonds is consistent with the state’s intensifying pressure from pension liabilities; by our calculation, the state’s unfunded pension liability (Moody’s adjusted net pension liability, or ANPL) for its five major plans in aggregate grew 25% in the year ended June 30, 2016, to $251 billion. The current rating also acknowledges intrinsic credit strengths, primarily the state’s sovereign powers over revenue and spending; a diverse and strong economic base with the long-term economic potential to provide for its liabilities, and statutory protections for bondholders, primarily requirements for monthly transfers in advance of semiannual debt service payment dates. During the past decade, the state’s governance framework has allowed practices that greatly offset these strengths. After eight downgrades in as many years, Illinois’ rating is an outlier among states, most of which are rated at least eight notches higher. The rating on the Build Illinois sales-tax revenue bonds is capped at the GO rating because of lack of sufficient segregation of pledged revenues from the state’s operating needs. The Met Pier and Civic Center program bonds are both rated a notch below the state GO bonds, because of the need for annual legislative appropriation of payments.

It’s a dire situation that really has no hope of improving. They have simply fallen too far behind on contributions to the pension funds to ever make it up. Not to mention, the state’s governor and legislature hasn’t agreed on a budget in nearly three years.

It’s simply not a state I’d invest in given the current risks. I wrote more about Illinois and the recent downgrade to Connecticut over at Seeking Alpha.

Puerto Rico Sales Tax (COFINA) Payments Held by Judge

June 1st was the due date for interest payments on Puerto Rico Sales Tax (COFINA) bonds.

From Bloomberg:

The $16 million payment on the bonds, known as Cofinas, and subsequent payments will be halted until several disputes over who owns the money — and who should get it — can be resolved, U.S. District Judge Laura Taylor Swain said Tuesday at a hearing in Manhattan federal court. It will be the first missed payment on the Cofinas, which had been paid on time even while other Puerto Rico debt went into default.

This means COFINA has defaulted and it continues to be an interesting development as the GO bondholders face-off with COFINA bondholders.

May Jobs Report was a Huge Disappointment

Treasury and muni yields fell following the jobs report on Friday. The market expected 182k nonfarm payroll jobs but actual jobs added were only 138k. To make matters worse, Aprils payroll gains were revised lower to 174k from 211k. Jim O’Sullivan at High Frequency Economics almost nailed it with an estimate of 140k. The number of new jobs should decline as the unemployment rate remains low.

Speaking of the unemployment rate, it fell to 4.3% but not for good reasons. Unfortunately the size of the labor force declined by 429k which lowered the participation rate from 62.7% from 62.9%. This could be due to the end of the college semester and college students heading home for the summer. Regardless, the three month average stands at just 120k jobs added per month which is below the 12 month average indicating a lower trajectory for the jobs market.

Muni yields continued to grind lower on the news. On average, muni yields fell 5 to 10 basis points on the week across the curve for bonds longer than 5 years to maturity. The market is still pricing in about a 90% chance the Fed hikes at their meeting next week.

Finding Opportunity in Connecticut

The recent downgrades to the state of Connecticut and Hartford has increased the number of CT bonds offered in the market. Yields are relatively higher compared to other munis due to the increased risk. I wouldn’t go long on CT state GO bonds but there could be opportunity to pick-up some yield on shorter bonds. The situation in Connecticut is bad….but no where close to as bad as Illinois.

I see 3-4 year CT state GO bonds offered at 1.5%-1.72%. Most municipal bonds are trading at around 70% of treasuries for 3-4 year maturities, CT state GO’s trade above 100% of treasuries indicating their relative cheapness. Things are not bad enough in CT for them to default in 3-4 years.

3 Yr CT State GO – 1.5% (101% of Treasury)

4 Yr CT State GO – 1.72% (104% of Treasury)

There are not many other municipalities that issue debt in CT. Various revenue supported debt structures from the state. Of course, there is Hartford debt out there but I wouldn’t buy BBB munis in this environment.

Overall muni yields remain low and will likely continue trending lower due to the supply constraints over the next month or two. If anyone has found a good deal in munis – feel free to pass it along!

 

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