April 1, 2020 – When I joined a bulge-bracket Public Finance shop in the 90s, my mentor touted the superior structure and fiscal qualities of municipal bonds.
We match the asset life with the tenure of the bonds, ensuring inter-generational equity!
We NEVER issue bullets, only amortizing debt just like home mortgages!
Muni debt structures ensure budgetary conservatism, minimizing the change of default and rollover risk!
For bankers who cover governmental issuers, the 30-year level debt service structure is almost a holy grail safeguarding against all fiscal irresponsibility. It’s a oldie but a goodie – like an old tee-shirt you’ve worn for 10 years when you were playing basketball and 20 pounds lighter.
Yes… I grant you – these structures are conservative in a technical sense since they stretch out an issuer’s debt repayment over a long period of time, at roughly equivalent amounts on each repayment (debt service) date.
And yes, the level debt structure does provide optionality to issuers given another artifact of municipal bonds – the 10 year par call. In fact, I would even venture into controversial terrain and argue that too many issuers are addicted to the 10-year par call, as it allows CFOs and Budget Heads to tout debt service and/or refunding savings that invariably save the day for cash-strapped municipalities – every year, like clockwork, like magic.
Here’s what doesn’t work.
When bond funds are experiencing robust inflows and yield curves are appreciably sloping (not too steep, not too flat), investors love traditional structures and are ambivalent – whatever issuers sell, investors will buy. Bankers and underwriters are co-conspirators in this regard, after all, who doesn’t love pocketing easy-to-come fees? The “integrity of the yield curve” is preserved as underwriters put together a 50-name order book with demand at every spot of the curve – all due to the marketing prowess of the underwriters (but of course).
That’s one scenario – and one that aptly describes the municipal market since 2010. When the going gets tougher however, as markets are currently, things get much more dicey.
Long-term investors are loathed to purchase long-dated risk assets as they contemplate the prospect of municipal credit potentially descent into the dark ages due to Covid-19. Investors are equally leary of short-term bonds, where the writing is on the wall and SIFMA will invariably reset at 0.05%. Again. Eventually.
So what would a Blackrock or PIMCO or Nuveen buy, in these unconventional, challenging times?
Probably a structure that doesn’t come forth from the cherished level-debt structure playbook? Structures that are perhaps just a bit more innovative and interesting?
How about index-eligible, billion-dollar-sized 5-year bullet maturities? Or 40-year taxable debt (after all – with 30-year Treasuries at 1.25%, what is the downside?). Or perhaps a rich coupon (any takers at 5%) for a 10-year note with a 3-year par call option?
There has been no greater need for innovation in the marketplace today, not since 2008.
Today, on April Fool’s day, even as AA+ and AAA-rated municipal issuers are shut out of the new issue market, Baa3-rated Carnival Cruises sold $4 billion of bonds. Yes Carnival paid dearly (over 10% in yield) but the near-distressed company also obtained a liquidity life line.
As municipal entities enter the next phase of the madness that is Covid-19, liquidity for both operating and capital expenditures will be paramount concerns. Many are going to find markets tough to navigate, and even tougher with clunky 30-year amortizing structures with $10M bonds in 2022, $11M bonds in 2023, $12M bonds in 2024 – you get the picture.
Our market has breadth and depth. After a century of the same old mindset on structuring and selling bonds, perhaps it is time to think about how we can be innovative again – and quicker to land on our feet.
Contact Caren Moses at CMoses@buymuni.com.
