The Muni Market: New Safe Haven or Potential Land Mine?

Transcription

1 The Muni Market: New Safe Haven or Potential Land Mine? Dennis Hudachek, Moderator Senior ETF Specialist IndexUniverse Patrick Smith, Panelist Chief Investment Officer Granite Springs Asset Management Paul Mansour, Panelist Managing Director and Research Analyst Conning

2 The Muni Market: New Safe Haven or Potential Land Mine? Dennis Hudachek Moderator Senior ETF Specialist IndexUniverse Patrick Smith Panelist Chief Investment Officer Granite Springs Asset Management Paul Mansour Panelist Managing Director & Research Analyst Conning

3 The Muni Market: Agenda Current Opportunities and Risks Passive vs Active Muni ETF Limitations Detroit Bankruptcy Puerto Rico Underfunded Pension Liabilities Government Shutdown Implications Munis and New Tax Rates Audience Q & A

4 Pick Up Yield with Callable Bonds Compare secondary market callable bonds to new issue serial bonds (non-callable). Cook County IL G.O. (Old Issue) 5.00% due 11/23 callable Par at $ = 3.12 YTC and 4.43 YTM Cook County IL G.O. (New Issue) 4.00% due 12/16 $ = 1.05 YTM Cook County IL G.O. (New Issue) 5.00% due 12/23 $ = 3.75 YTM Pick up 207 bps in 2016 and 68 bps in 2023.

5 Cushion with Callable Bonds Compare duration profile of callable bond to noncallable bonds. Cook County IL G.O. 5.00% due 11/23 callable Par at $ (3.12 YTC/4.43 YTM) DUR 2.38 years / 7.76 years. Cook County IL G.O. (New Issue) 4.00% due 12/16 $ (1.05 YTM) DUR 2.95 years. Cook County IL G.O. (New Issue) 5.00% due 12/23 $ (3.75 YTM) DUR 8.02 years. Caveat: callable bond duration jumps when price falls below par.

6 Sensible Yield Curve Positioning 15 Year Muni (3.92) is 91.59% of 30 Year Muni (4.28) with 30% less duration!

7 Municipal Market Offers Value Municipal to Treasury yields are attractive New Issue volume is expected to remain muted Municipal credit quality is improving Payment defaults and bankruptcies will continue to be infrequent Some high profile municipal trouble spots

8 Municipal Bond defaults rare events Investment-grade municipals have had lower default rates than initially rated Aaa corporate bonds First time payment defaults in 2013 are less than in 2012 Essential purpose revenue and GO bonds have excellent payment records Chapter 9 bankruptcy is a not viable option for most municipal credits Only 24 states permit it Requires proof of insolvency, that all measures were used to avoid to and good faith negotiations Expensive with an uncertain outcome Timely process that could take 3 years

9 State Revenues Growth continues

10 State Expenditures Growth Kept in Check

11 General Fund Balances - Recovering

12 Revenue Bonds Benefiting from the economic recovery Essential service water and sewer, electric, transportation health care Stable and more predictable revenue and expenses Capital intensive sector lower interest rates have meant improved debt service coverage Bond covenants - provide reserves and protection against dilution Business activities no political risk Bonds backed by special revenues have been held harmless in Chapter 9 bankruptcies

13 State, sector and credit type matters State credit quality is determined by Business conditions Economic indicators GO credit indicators Sector types Dedicated tax sales, gas and income tax Revenue Bond utilities, transportation and healthcare Tax backed state and local with multiple security features Specific credit metrics Security features Financial review Economic and business analysis State, sector and credit selection is critical for strong investment performance and avoiding trouble spots

14 Credit quality differences among the states - wide Source Conning State of the States April 2013

15 Municipal Bond Trouble Spots Years in the making Cities with declining economics and legacy costs Detroit Harrisburg Commonwealth of Puerto Rico Contracting economy Chronic operating deficits High debt levels with need finance deficits through debt issuance California Cities Stockton and San Bernardino both in Chapter 9 bankruptcy Real estate collapse, high labor costs and inability to raise revenues State of Illinois and metro Chicago credits Large unfunded pension and OPEB liabilities Political stalemate which to date has blocked any plan changes Declining economic metrics - employment

16 Pension Underfunding How serious? Key Facts States have $3 trillion of unfunded pension liabilities using realistic discount rates Many States have very unfunded plans less than 80% History of not making 100% of plan required contributions continues Credits Concerns Pension contributions are a rapidly growing general fund expenditure item Longevity and investment returns are outside of the control of the state Despite plan adjustments unfunded pension liabilities continue to grow No longer an overlooked credit issue Moody s and S&P have updated their criteria to more heavily weigh pension obligations New GASB rules will standardize accounting methods and result in higher liabilities reported in financial statements Public debate and Meredith Whitney have raised public awareness The credit penalty of having a seriously unfunded is rising

17 Pension Funding Improvement Remains Elusive

18 Market Vectors High Yield Municipal ETF (HYD) Premium/Discount 2013 Year-to-Date Source: Bloomberg

19 Tough Year (so far) for Muni ETFs 2013 YTD Max Drawdown & Standard Deviation (Annualized)

20 Largest Tax Exempt Muni ETFs

21 Relative Value?

22 Conning About US Conning ( is a leading investment management company for the global insurance industry. Conning is focused on the future, supporting the insurance industry with innovative financial solutions, investment experience, and proprietary research. The company s unique combination of asset management, risk and capital management software, and advisory solutions, as well as insurance research, helps clients achieve their financial goals through customized business and investment strategies. Founded in 1912, the company is headquartered in Hartford, Connecticut, and serves its global client base from additional offices in Purchase, London, Cologne, and Hong Kong. This presentation has been prepared for and distributed exclusively to conference participants. Further distribution, sale, or reproduction, in whole or in part, and by any means, is prohibited. Statements and information in this report were compiled from sources that we consider to be reliable or are expressions of our opinion. The presentation is not intended to be complete, and we do not guarantee its accuracy. It does not constitute and must not be considered investment advice. Conning is a portfolio company of the funds managed by Aquiline Capital Partners LLC ( Aquiline ), a New York-based private equity firm.

23 Thank you. Questions?