GOLDEN OPPORTUNITIES CALIFORNIA PUBLIC FINANCE ROADSHOW 2014 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC.
Agenda Welcome and Introductions Rob Larkins U.S. Economic Outlook and Interest Rate Forecast Dr. Donald Ratajczak 2014 Macro Municipal Market Themes Don O Brien California Market Outlook Parker Colvin Current Reinvestment Opportunities David Sutton
Interest Rate Forecast by Dr. Donald Ratajczak As my monthly analysis indicates, the 10 year treasury should be yielding about 3.1% if not for two additional factors that alter rates in the short run. First, the flow of funds shows our government lowering its need for resources, our corporations beginning to lower inventory investment without yet committing to strong capital spending, and our household sector receiving enough wage compensation to preserve current living standards and still replace old cars and remodel homes. In short, fewer funds need to be enticed from abroad to preserve our current growth activity than last year. Second, alternatives to our bonds are diminishing in attractiveness. Greek bonds with a 4.75% return and Irish bonds yielding 2.92% for ten years definitely limit the yield that would be needed to clear our borrowing markets. Moreover, the ECB continues to explore further easing tools. In other words, U.S. long rates could even fall further before they must inevitably respond to rising pressures as the period of controlled short term rates approaches an end. Such an end is not likely before the second half of 2015, but the beginning of the end is certainly possible before 2016. The flow of funds should remain favorable into the fall, but not much beyond that. I am not yet sure how European rates will settle, though even those successful bidders began losing money soon after their bids were accepted. If not for the Rajoy and Hollande concerns about the euro, I would be content to assume that Europe already has provided the most attractive alternatives they will in this cycle. However, I must now wait to see how the ECB (and more importantly, Germany) reacts to the prime ministers requests. In the meantime, don t expect much lower yields, but also don t look for sharply rising rates until the euro question is put to bed.
Interest Rate Forecast by Dr. Donald Ratajczak
A Brief Historical Interlude: What s Changed Since 2004? 2004-2007: Golden Age of Bonds--robust volume, unquestioned liquidity, +50% insured, credit irrelevant, direct retail, bond funds and Tender Option Bonds dominant Monthly Municipal Bond Fund Flows 2008: The music stopped. Insurers lost bullet proof AAAs; Bear, Lehman, Merrill disappeared 2009: Build America Bonds introduced municipal credits to investors in the taxable market who had not previously considered municipals 2010: Credit deterioration and uncertainty (Meredith Whitney) increased the focus on municipals by non-traditional municipal investors 30-Year Muni/Treasury Ratios 2011-today: Decline of Tender Option Bond buyer base, further credit deterioration (Detroit/PR); municipal bond fund outflows coupled with consistently lower new issuance have focused the market on the ratio trade
Capturing the Shift in Buying Power: TOBs to Ratio Traders * Assumes $500 million level debt service
Where Are We Today? Interest Rates Remain Very Attractive in a Historical Context Interest Rate Intensity Map (MMD Yields - 1993 to Current) 8 % 7 6 5 4 3 Term 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 2 1 0 Current MMD: 92.6% of the time, 30-yr bonds have been above the current rate since 1993. (years) 0.00%-3.00% 3.00%-6.00% 6.00%-9.00% 9.00%-12.00% 12.00%-15.00% 15.00%-18.00% 18.00%-21.00% Current The graph above shows the frequency of MMD rates since 1993. The more intense the color, the more often interest rates are at the given level, moving in intensity from light red to dark red.
Muni Market has Started 2014 with a Powerful Rally Redemption Reinvestment - Holders of California municipal bonds faced a historically high redemption period in 2013. Redemptions are projected to peak again in June 2014 good time to issue. MMD Rates (Current vs. Beginning of Year) 1/2/2014 4/4/2014 Change in Rates (%) 1/2/2014 4/4/2014 Change in Rates (%) 2015 0.17 0.15-0.02 2030 3.60 3.10-0.50 2016 0.35 0.39 0.04 2031 3.69 3.17-0.52 2017 0.59 0.68 0.09 2032 3.77 3.24-0.53 2018 0.92 0.98 0.06 2033 3.83 3.31-0.52 2019 1.32 1.30-0.02 2034 3.89 3.36-0.53 2020 1.73 1.66-0.07 2035 3.94 3.41-0.53 2021 2.10 1.94-0.16 2036 3.99 3.46-0.53 2022 2.39 2.18-0.21 2037 4.04 3.50-0.54 2023 2.62 2.36-0.26 2038 4.08 3.53-0.55 2024 2.79 2.49-0.30 2039 4.11 3.56-0.55 2025 2.93 2.60-0.33 2040 4.14 3.58-0.56 2026 3.08 2.71-0.37 2041 4.17 3.60-0.57 2027 3.24 2.82-0.42 2042 4.18 3.62-0.56 2028 3.38 2.92-0.46 2043 4.19 3.63-0.56 2029 3.50 3.01-0.49 2044 4.20 3.64-0.56 California Bond Redemptions * * Principal only
Market has Responded Favorably to the Governor s Proposed Budget Surging tech sector generating a tsunami of capital gains $4 billion Total budgeted revenue= $106 billion, less $1.6 billion to Budget Stabilization Fund Reflecting reduction in Wall of Debt and budgeted reserves, S&P raised State s outlook to positive, suggesting possible upgrade to A+ Lack of supply, increased demand from Prop 30 income tax increase, and the prevailing improved credit perception has compressed spreads throughout the California market
Local Spreads are Benefitting as Well Investor preference for GOs and essential service Revenue Bonds still firmly in place For high grade credits, California penalty is now transforming back to a California premium Lack of supply is forcing investors back into Lease Revs and COPs All spreads compressing, across the curve 0.7 0.6 0.5 0.4 0.3 0.2 0.1 EBMUD Spread to MMD (bps) Series 2012B, 2020-2022 Maturities 0.0 Oct-12 Jan-13 Apr-13 Jul-13 Nov-13 1.6 County of Los Angeles Spread to MMD (bps) Series 2012, 2022-2023 Maturities 1.4 3.0 1.2 2.5 1.0 2.0 0.8 0.6 1.5 0.4 1.0 0.2 0.5 0.0 0.0 Feb-12 Aug-12 Mar-13 Sep-13 Apr-14 Mar-10 Jul-11 Nov-12 3.5 County of Sacrmento Spread to MMD (bps) Series 2010 2030 Maturity 2.5 2.0 1.5 1.0 0.5 City & County of San Francisco Spread to MMD (bps) Series 2007A 2040 Maturity 0.0 Aug-10 Dec-11 Apr-13 Spreads to MMD EBMUD Spreads to MMD LA County Spreads to MMD Sacramento Spreads to MMD San Francisco Original Pricing 28 bps Original Pricing 118 bps Original Pricing 197 bps (Ins) Original Pricing 49 bps (Ins) April 2013 Trade 40 bps April 2013 Trade 120 bps April 2013 Trade 173 bps April 2013 Trade 153 bps Recent Trade 3 bps Recent Trade 79 bps Recent Trade 102 bps Recent Trade 82 bps
Year-Over-Year National vs California Issuance In contrast to the national trend, 2013 refunding volume was relatively flat in California compared to 2012. This is largely attributable to a 22%, or $1.8 billion, increase in refundings at the State level. New Money issuance was decidedly down in California in 2013 YTD California volume is down considerably relative to National National ($MM) 2012 2013 Percent Change Refunding 158,221.60 111,252.90-29.69% New Money 146,008.80 161,345.50 10.50% Combination 75,378.50 61,056.80-19.00% Total 379,608.90 333,655.20-12.11% 24% Decline California ($MM) 2012 2013 Percent Change Refunding 16,826.70 18,627.00 10.70% New Money 31,079.00 19,975.80-35.73% Combination 12,017.10 8,614.80-28.31% Total 59,922.80 47,217.60-21.20% 42% Decline
Opportunities in Land Secured and Tax Allocation Markets Land-secured supply continues to grow from refundings and resurgence of new projects Tax Allocation supply picking up as Successor Agencies work on +$1.5 billion in refunding candidates Credit spreads have compressed dramatically Renewed investor confidence in real estate market benefitting all credits
Opportunities in K-12 and Community College District Markets Assessed Values are recovering along with the real estate market Bonding capacity is coming back, and tax rate pressure is seeing some relief Reliance on State budget for per pupil revenue less of a concern; average funding increase of 10% seen as positive by investors LCFF supplemental/concentration grants produce greater revenue increase for many districts Great time to re-brand school district credits as Prop 30 revenue increases are temporary Rating agencies and investors still blur the lines between operating budgets and GO bond security
What s Happening at the Short End? Drought of money-fund eligible floating rate product has driven SIFMA to 3-6 bps 0.35 0.30 SIFMA Index vs. One-Month LIBOR Historical Rates SIFMA Index 1 Month LIBOR 0.25 Yield (%) 0.20 0.15 0.10 0.05 0.00 Source: SIFMA VRDO Update dated January 10, 2014. Outstanding requires a minimum of one reset before end of month. Net Issuance reflects new issuance less partial amortization from sinking funds, pre-payments, partial tenders, etc.
Short Term Market Opportunities Money fund assets have stabilized at approximately $270 billion Yield curve inside 1 year continues to offer benefit from stub maturities $280,000 $275,000 $270,000 $265,000 $260,000 $255,000 $250,000 $245,000 Tax-Exempt Money Market Fund Assets ($MM) 8/13 - Present 0.20% 0.15% 0.10% 0.05% MMD Short-Term T-E Yields (MIG-1) 4/4/14 0.13% 0.11% 0.07% 0.06% 0.15% $240,000 0.00% SIFMA Index 1-Month 6-Month 9-Month 12-Month In current market, we estimate one year* high-grade SIFMA Notes would clear the market at SIFMA + 3 bps, or 9 bps * Maturity (TRANs) or hard put
In Conclusion The broader market has provided another window of low short and long term rates California credit performance has enhanced the attractiveness of this window All data suggest this window is temporary Increased future supply Nonpermanent factors in California credit improvement Future Fed Policy
Re-Investment Market The World Has Changed The world is not the same and not going to be for the foreseeable future Creativity is at a premium, especially in such a low rate environment Laddered portfolios Project funds Commercial Paper DSRF s Many more hybrid investment solutions
Rising Rates Create Opportunities Issuers have suffered through several years of either negligible or declining interest earnings on bond proceeds. The increase in investment rates since mid-2013 affords the following opportunities: Project/Capitalized Interest/Bond Funds: higher cash-flow earnings equates to smaller borrowing amounts. QSCB Sinking Funds: ability to come close to or achieve the max PSFY and to minimize required deposits. Reserve Funds: increased likelihood of recapturing escrow negative arbitrage with reserve fund positive arbitrage. * Source: Treasury.gov
Opportunities for QSCB s Clients have the ability to enter into long-term investment agreements that pay a fixed rate on all sinking fund deposits rather than making discrete annual investments of the deposits; QSCB investment agreement rates have increased in the past 9-12 months, enabling many clients the opportunity to achieve 75-100% of their maximum PSFY ; Numerous clients have elected to either execute such agreements or to establish a rate target via a parameters resolution. * Hypothetical examples, for illustrative purposes only. Swap estimates derived from Bloomberg.
Opportunities for Reserve Funds Can re-capture negative arbitrage over the life of the deal. Any re-capture effectively increases refunding savings. Amount of recapture is dependent upon timing and the rate of investment. *Sources: Thomson Reuters, Providers, and historical estimations.
Reserve Fund Opportunities to Enhance Savings/Earnings *Hypothetical examples, for illustrative purposes only.
Historical Investment Rate Estimates *Sources: Bloomberg, Providers, and historical estimations.
GOLDEN OPPORTUNITIES CALIFORNIA PUBLIC FINANCE ROADSHOW 2014 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC.