Municipal Fixed Income Update

Key takeaways – Market and strategy

Right now, the market is trying to determine how to price in the impact of a still to-be-determined decline in municipal revenues (e.g. sales and income taxes, user fees, toll revenues, etc.). Ten-year municipal/Treasury yield ratios have moved from approximately 80% at year-end to 160% as of March 17. This could lead opportunistic “crossover/non-tax-sensitive” investors to consider entering the market along with potentially increased demand from tax-sensitive investors.

What’s happened?

• The municipal fixed income market is currently experiencing a significant dislocation. The bid side is weak due to dealers' inability to hedge their positions and inventory.
• Municipal yields have fully reversed the declines that occurred from December 2019 through February 2020 and are now approximately 30 basis points higher across the “AAA” curve.
• Municipal/Treasury yield ratios have widened significantly and currently exceed 150% of Treasury yields out to 10 years and are slightly lower out to 30 years.
• The municipal/Treasury yield ratios are inverted (i.e., ratios decrease from 2-year to 30-year maturities); this is a full reversal from where we stood at the end of February 2020.
• Municipal credit spreads have widened substantially particularly in lower rated issuers.
• The new issue market is largely operating on a day-to-day basis; we expect issuers to resume activity as interest develops.

What are you keeping an eye on?

The potential economic disruption that is occurring across the globe is unprecedented.  Furthermore, the duration of the disruption is both uncertain and dependent upon the ability of healthcare systems worldwide to arrest the growth trajectory of COVID-19. 

But while the economic disruption is unprecedented, so too will be the scale of economic stimulus provided by policymakers across developed markets. Central banks have already reduced rates sharply and are providing an extraordinary amount of liquidity to help keep markets functioning and businesses able to access funding. We expect that the fiscal response will be unparalleled as well, as governments step up to help provide emergency cash assistance to the individuals and industries most directly impacted by this crisis.

Sectors impacted most immediately and directly include the following: 

	Transportation Airports Domestic and international travel are both expected to be significantly impaired with a decrease in tourism and business travel and the increasing threat potential of broad travel restrictions. Enplanement declines and significant capacity cuts increase the likelihood that a breach in the rate covenant could lead to a technical default. If covenants are breached this would authorize an increase in rates from the airlines to facilitate cost recovery. Federal aid to the airline industry (seeking $50 billion) would be a positive to help provide financial stability. Positively, airports have significant cash on hand to help mitigate the risk of bondholder impairment.
	Ports Ports are a key part of global supply chains. Shipping activity has slowed and further slowing is possible. While we expect COVID-19 to have an adverse effect on shipping volumes, ports generally structure the contracts with their shipping “tenants” to have a minimum guaranteed amount. There is potential impact on shippers’ ability to make payments.
	Hospitals The Centers for Medicare & Medicaid Services have released a special coronavirus reimbursement code for hospitals and physicians while managed care providers will reimburse for physician visits and hospital stays. Given that the virus seems to disproportionately impact elderly populations we expect that a larger number of inpatient admissions will be Medicare patients. Healthcare providers may experience an uptick in “bad debt” due to non-payment from private-pay patients who have not reached their deductible and co-pay limits.
	Tourism and sales-tax-dependent municipal credits Lost sales tax revenue from conventions and travel in general will need to be evaluated.

Past performance is no guarantee of future results.

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