Since the dizzying spring spikes in municipal market bond yields, the Federal Reserve’s stimulus programs have fueled a rebound in muni market prices to all-time highs and yields back to historic lows. Despite the Fed’s lifelines, muni market fundamentals remain challenged and price risk high.
The Muni Market’s Fed-sponsored Round Trip
Dominic Alto: Hi, welcome to another episode of “Away from the Noise”, Thornburg Investment Management’s podcast on key investment topics, economics, and markets developments of the day. Uh, we’re recording from our home offices. I’m Dominic Alto, Client Portfolio Manager at Thornburg. Joining me today is Dave Ashley, Portfolio Manager of Municipal Strategies. Thanks for taking some time to join me today, Dave.
Dave Ashley: Thanks Dom, good to talk with you.
Dominic Alto: So, uh, Dave, I’d like to start off first with just a little recap on what we’re seeing in the market; you know, ,the municipal market much like, uh, the equity markets are essentially at all-time highs again coming off of, uh, the disruption we saw with COVID and the economic shutdown back in March and April. I’d love to get your thoughts, you know, now that the market has essentially gotten back to all-time lows and yields. Last year we saw that driven heavily by retail fund flows. I’d be interested in your thoughts on really what’s been driving that since, since the end of April.
Dave Ashley: Um, it’s kind of interesting, you know; we, we kind of round-trip rates going back through, you know, from February, February lows to March highs back to kind of June lows; so the value proposition has kind, you know, evaporated in, in, in the space and I think a large component of that is, has been the Fed backstop which has allowed, you know, more confidence in the market to go back in there and, and, and feel, feel better about buying bonds at certain levels; uh, especially Illinois which came two weeks ago. They didn’t use the Fed backstop that particular time, but their deal was oversubscribe; so, you know, the market I think felt comfortable with that, that the levels were kind of capped at a certain, at a certain point so that brought in a, a, you know, a different buyer base because up to that point in time; you know, the Illinois, the New Jerseys, et cetera, had, had kind of been, uh, the line credits and, and wind out statewide.
Dominic Alto: Now you mentioned the Fed backstop and I think that that’s an interesting point to touch on. The Fed in particular, uh, many investors know that, they’ve had a lot of, uh, intervention on the taxable side or the taxable fixed income market, but I don’t believe that that’s necessarily been the same in the muni market; so I’d be interested in just, uh, you know, maybe a synopsis of what they are or are not doing in the muni market that’s similar to some of the other fixed income markets that they’re intervening in.
Dave Ashley: Um, the Fed has been kind of removed from the market. I mean they, they’d kind of been there, uh, you know, kind of in the shadows; um, and I think they gave, um, investors confidence to go back into the market, but the MPA is gonna be able to borrow directly from the Fed program and they’re gonna tap that program; so the MPA is the transit system for the, uh, New City Metro Area and the second borrower that’s, that’s tapped, um, the municipal liquidity facility as, as it’s called, is the state of Illinois for $1.2 billion in cash flow notes that they’ll pay back next year and I think the rate was in the, the 380 range which is, you know, well above, perhaps, going market rates in the, you know, the one-year space which is probably in the, you know, the 20 basis-point range.
Dominic Alto: When you mention the facility specifically you’re talking about the Fed liquidity facility and so that’s, essentially they have a lending to municipalities right? They’re, they’re not coming in and, and buying bonds per se or doing anything like that. It’s, it’s, it’s more of a borrowing facility?
Dave Ashley: Correct, yeah they’re, they’re not a, they’re not in the secondary market buying bonds and, you know, kind of like they’re doing in the corporate space where they’re actually buying ETFs HYD which is the High Yield Index or L, LQD which is the Investment Grade Index, Corporate Investment-Grade Index; and even there they haven’t actually done a ton of buying. It’s just been that perception that they’re there and I think that perception’s been very, very powerful. You know, we’ve seen it in the equity markets for, for, for sure and then we’re also seeing it in the bond market too in, in the high yield space, the flows in the high yield corporate, investment grade corporates and, you know, we saw the return to flows in munis as well; so I mean, because that confidence is, is, is kind of, uh, you know, emboldening folks to come back into the space and, uh, unfortunately with everybody coming back into the space at one time, you know, it’s kind of driven valuations to kind of steamy levels, frothy levels, which has left, you know, a lot more price risk on the table and a lot less income; so you know, we, we, you know, we need to tread carefully going forward here from this, this point forward.
Dominic Alto: Yeah, no, that’s, that’s certainly a, an important thing to take into consideration and, and I think it’s, you know, very important to understand again that, you know, the Fed is lending directly, um, and the fact that they are not buying in our market would suggest that the, the level support maybe isn’t there that, that most investors, uh, think. I know along with this Fed liquidity facility, uh, there’s certainly been some fiscal stimulus and, and other things that have been tied to our market; but I, I guess I’d be interested in finding out from you, you know, is, is that reaching the correct areas? Obviously, there’s some troubled sectors which I would love to touch on, but, you know, more specifically, uh, are we seeing those dollars make it in to support these revenue shortfalls, um, because that’s certainly what’s been grabbing the attention and grabbing the headlines; is just the amount of revenue that’s been lost to this, this economic shutdown that occurred over the last several months.
Dave Ashley: Sure, I mean just you know, through the CARES Act there’s been, you know, there, there’s been funding mechanisms to help, uh, higher ed. There’s some funding mechanisms for hospitals, you know, stabilize governments; so I mean, you know, there’s, there’s, there’s money that’s going into the right places which is difficult to replace two or three months’ of revenue, uh, at, at, at full employment versus, you know, 20 percent unemployment or I guess 13.3 percent we saw on Friday which was kind of a, a very interesting, um, BLS result; um, kind of more art than science I think, given, uh, if, if you read into the actual BLS report. You know, employment should have been more like 16.3 percent, but I’m gonna, we’ll let the statisticians, I guess, deal with their models. So yeah I mean, I mean it’s, it’s, it’s making it to the, to, to certain areas, but I mean I think, you know, there’s also a political aspect to this, you know, when, when the Fed’s spigot’s kind of wide open. There’s, you know, an incentive to like, hey, we might need more money than we poss, than, than we might need to replace that we lost; so I think, you know I think, you know, definitely McConnell on this, McConnell is being very hesitant to, you know, to kind of bail out those states that have already had like maybe more, they already had their intrinsic issues so he, you know, he’s, he’s, I think he’s more than willing to help get them through, uh, and bridge them through this, this, this period of distress, but he’s not, at least, you know, rhetorically he’s not in the business of bailing out, you know, the blue states as he, as he, as he’s, as he calls them, you know; the Illinois, the New Yorks and so on forth that, that may have, you know, a little more policy spending issues along with liability issues associated with their pension.
Dominic Alto: Yeah, so I think the state and local municipality question’s an interesting one. Um, certainly you mentioned Mitch McConnell; he had made comments, I guess this is now a couple months ago, but that he would essentially prefer to allow states to go bankrupt than to bail them out. I would be interested in your thoughts maybe around the state bankruptcy. Uh, it’s certainly something that’s never occurred and, and maybe create some incorrect incentives in the market, but I know that the states, at least the dollar amounts of, of revenue shortfalls have grown pretty steadily when some of that tried to get worked into a second CARES Act program giving hundreds of billions or maybe even a trillion dollars, um; so, so really that hasn’t made its way through so there’s still some stress there, but again, you know, your, your thoughts on state bankruptcy and maybe the, some of the challenges that they’re seeing from a revenue shortfall standpoint.
Dave Ashley: Yeah, I think the, the state bankruptcy thing is, is interesting because, you know, it’s, it’s, it, it may be a way for, you know, certain states or entities to get out of, you know, overburdened liabilities associated with their pensions or post-retirement health care obligations, et cetera, but I think that there’s a distinction between, you know, the state of Illinois and say Toys R Us because Toys R Us is a for-profit entity. You know, if they go out of business, you know, somebody else is gonna maybe backfill them with a different type of business model, to sell toys et cetera, right? But the state of Illinois has been, has been there for a long time and it’s probably gonna be there in perpetuity; so allowing them to like file for bankruptcy, you know, where we organize their debts, et cetera; we create like this incentive about every 10 to 20 years to like lever up, lever up, lever up, promise, promise, promise; and then go back to the bankruptcy process which I think would be difficult from an investor standpoint because then the investor’s gonna expect more return or more, re, return for their risk for investment in the, in these entities which in turn is gonna raise the borrowing costs for state and localities as opposed to keeping it as low as possible through, you know, the current muni mechanism – so I think the bankruptcy thing is just more of a, you know, political talking point again, and, and not very feasible in, in terms of, of actually implementing it at the state level or, you know, uh, in particular the state level.
Dominic Alto: Yeah, uh, no, I think that makes sense. Um, so something you mentioned earlier which, uh, I think is, is worth talking about are a couple of the sectors that have certainly been challenged with everything that’s going on. One you mentioned earlier was, was higher education; so I think there’s been a big question mark around the value proposition with higher education as costs have soared, uh, and the amount of student debt, uh, students have taken on has, has become exorbitant. I know you mentioned some money has made its way there through the CARES Act, but I’m wondering how you’re approaching, uh, a sector like higher education which is very diverse and, and is certainly running into, uh, some challenges.
Dave Ashley: I mean within the sector, uh, you know, we’re, we’re gonna see some, some pressure points, you know? The, the small liberal arts college, you know, that’s just like the other small liberal arts college; that’s just like the other one and another one – I mean, I think you’re gonna have some pressures in those areas especially if their endowments aren’t as, as, as robust as some of the other schools, perhaps in that, in that segment, you know, let’s say Swarthmore versus like, um, you know, a smaller liberal arts school in, in a very regional area that, that can’t compete with Swarthmore or something like that. With that said, we’re starting to see, you know, with the, the credits we’re starting to see campuses opening up for fall enrollment, perhaps at reduced rates. You know, I think looking at northern Arizona they’re looking at probably like a 20-percent decline in fall enrollment, but I mean to make the, the whole higher ed equation work, especially for students, I mean you have to have that on-campus experience. Um, if not I mean, everything goes online because the whole point of being on campus is to make friends, to network, you know, interact with people, you know, in, in a physical way and, and get to know people for, you know, for, for lifetime friends and so forth; so I think the, the on-campus experience comes back. I think it just takes a little bit of time as they work through how to, you know, handle COVID restrictions. You know, do we have, you know, 80 percent classes full or 70 percent classes full versus, you know, 100 percent. You know, how do we do the dorms, et cetera, but I think those are all problems that can be solved and I think as the COVID, um, pandemic kind of starts to, to, to moderate over time, especially over the, the summertime; I think those fears will start to displace themselves and you’ll, we’ll start to see better acceptance of enrollment. Um, as to the affordability component; that’s a whole different idea. That’s a whole different argument. Um, I too agree it’s probably a little overvalued, um, but those are also list prices; so once you start looking at tuition discounting and so forth, you start to see like, okay, you know, you’re going to school and, and, and room and board plus tuition is about 60 grand without the tuition discounting and some other things, you know, you’re probably closer to 35, 40 which is, you know, still, you know, an, an awful lot of money for one year of education, but sometimes it’s difficult, it’s, it’s hard to, you need to get past the list price and get back to the actual price that, that the students’ families are actually paying.
Dominic Alto: Yeah, no, I think that makes sense, but I can certainly see how some of those challenges would play out. Uh, you know there’s one other sector in particular, uh, that I thought was adventurous just given everything that’s gone on with the pandemic; and those are continuing care retirement centers or CCRCs; um, and, you know, nursing homes were kind of the, the first wave of the epidemic. Um, it was really where these things started in Seattle, uh, and I know a, a large amount of some of the cases as well as unfortunately fatalities have been in retirement centers or nursing centers, nursing homes; um, it certainly seems to me that that’s an area that’s going to be impacted. Um, I’m interested in just, in what you’ve seen play out in that sector, uh, over the last couple months.
Dave Ashley: Yeah, I mean we’ve, we’ve definitely seen some, some pricing pressure on the, on the few facilities that we own given, you know, that there has been a higher instance of, uh, of death in those facilities. With that said, I, I mean that’s, with that said I think the value of those facilities is still there. Um, you know like you said, continuing care retirement facilities, um, they kind of cater to a, a little bit different demographic, you know, pretty much, you know, existing homeowners with, with some financial assets. Um, they offer, you know, you come in through independent living; so, you know, you have a home or apartment and you, you get a little bit of help here and there if you need it, but if not, you, you know you’re fine; and then as you kind of transition through, you know, at the end of life you go to like assisted living. Um, if you need some skilled nursing, it’s available, and then also memory care is usually available at these facilities so they tend to be a little bit more, um, robust, more amenity filled, I guess – but on the skilled nursing side, um, that tends to skew more to folks that don’t have as many assets; so they’re a little bit more of a higher Medicaid base, but once again, a very valuable service, right, to, to, uh, you know, for elderly folks that need medical assistance in, in later stages of their life so I think even though we’ve seen higher instances of these, of, of COVID deaths in these facilities, um, their, their, their viability is still, is still good, but I think after going through the pandemic you’re gonna see probably different protocols, maybe a little bit more expensive just because of the things you have to do to keep sanitized and perhaps a little bit more separated, uh, when things break out, but I think once you see their viability and, and there’s no alternative yet; you’re gonna have to have these facilities and you’re just gonna have to make the appropriate changes to protocols in terms of, you know, admittance, disease management and then, you know, obviously, uh, quarantining when, when that becomes necessary.
Dominic Alto: I think that makes a lot of sense. Well Dave, I’d like to thank you for your time today. It’s always a pleasure speaking with you.
Dave Ashley: All right, Dom, it was good to talk to you as well.
Dominic Alto: And thank you for listening. You can find us on Thornburg dot com, forward slash, Podcast; as well as on Apple Podcast where you can rate, subscribe and review us; and please join us for the next episode of “Away from the Noise”. Thanks again for your time.
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