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Weekly Insights of a Municipal Bond Trader

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Municipal Market Overview

During the month of July 2019, 30-year Treasury interest rates remained unchanged and 30-year MMD rates declined by 7 basis point to 2.24%. Long-term new issue supply was $25.1 billion for July, down about 10.3% from last July. Year to July-end issuance was $196.6 billion, up about 1.5% from the same period last year. The story this year of strong demand and modest supply continues. Long-term municipal bond mutual funds continue to see very positive flows, reaching 32 consecutive weeks of inflows.

Puerto Rico Credit Implications

Puerto Rico’s special revenue ruling is beginning to have an impact on the ratings of other bonds. The courts said that Puerto Rico is not required to pay debt service on “special revenue” bonds during its Title III bankruptcy proceeding, and this was upheld by the appellate court. Before this ruling, market participants believe that special revenue bonds were insulated from repayment risk during bankruptcy proceedings. The 1st Circuit Court affirmed that special revenue payments are voluntary rather than mandatory. Moody’s placed eight credits on review for downgrade following this appellate court ruling. One of these, Cleveland Revenue bonds, were downgraded by one notch recently by Moody’s but remain higher rated than the general obligation bonds of the city of Cleveland. Kroll Bond Rating Agency is also reviewing some credits due to this ruling and recently upgraded the Los Angeles Unified School District (LAUSD), the second largest school district in the country, to AAA from AA+ as they viewed this ruling as strengthening their view on the protections afforded this credit by California law and the payment mechanics. By state law, LA County property tax collections can only be used for one purpose, to pay debt service on specific bonds. The Puerto Rico ruling said that it applies “absent state law that specifically governs the use of special revenues.” Clear state laws can protect the bondholders.

Bank Qualified

Rep. Terri Sewell, Democrat, and Rep. Tom Reed, Republican, filed bipartisan legislation to increase the limit on issuance to be bank qualified from $10 million to $30 million plus a cost of living adjustment. Bank qualified paper allows banks to avoid disallowing interest expense associated with the purchase of these tax-exempt securities, which would be required for the purchase of non-bank qualified bonds. This allows a tax arbitrage, deductibility of interest expense while receiving tax-exempt interest, for these bonds for banks to encourage them to buy the paper of smaller issuers. The higher limit of $30 million was allowed in 2009 and 2010 as a part of the American Recovery and Reinvestment Act passed during the financial crisis.

Federal Reserve

The market is fully expecting an ease at the September meeting of the Federal Reserve Board, with the implied probabilities from the futures markets giving a 95% probability of a 25 basis-point ease and a 5% probability of a 50 basis-point ease. There are several weeks before the Fed meets, so there is some chance that market volatility and trade war tweets will have subsided before the next meeting. The discussion of whether this ease remains a part of a “mid-cycle correction” will be a main focus for investors at this meeting.

Portfolio Positioning

We are maintaining our average maturity to about 13.6 years, and our duration to about 5.3 years.

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