Big Spreads in Atlantic City
For those who all but threw in the towel on Atlantic City, New Jersey, comes a spot of positive news this week with a slight thumbs up from Moody’s Investor Service. Following the closure of four casinos last year and the subsequent appointment of an emergency manager in January, the City has been demonized by municipal investors. Spreads widened this year, well over 100 basis points in some instances from February as the situation looked more ominous and options more limited. However, recent reports from Atlantic City’s finance department detail how the City not only is able to make its August 15th debt service payment, but that the City also has enough cash on hand to fund well into October, barring any unforeseen collectability issues with fall property taxes. What makes this positive news a bit more intriguing is that the City has not had any prolonged legal costs incurred yet in dealing with property tax appeals from casinos and perhaps the cushion of funding will inspire Governor Christie to strike while the iron is hot and sign a rescue package for the City to let them build on this momentum. His rescue package would create a PILOT (payment in lieu of taxes) program which would eliminate some of the uncertainty surrounding property taxes, their potential for appeals and ultimately collectability.
Calmer Waters Across the Ocean
On the rates front, this was a week that was calmer than those in recent past, with issues in both Greece and China becoming more muted. Greek banks reopened on July 19th after an almost 3-week shutdown, this time with capital controls and withdrawal restrictions in place. EU officials are hopeful that finalized bailout plans will be in place before the end of the summer. Meanwhile, China has continued to recoup some of the losses that came after the stock market there took a large hit from the peak in mid-June. The government in China has gone to great lengths to help the markets, including rate cuts, halting IPOs and even threatening to arrest short-sellers! As such, US markets continued to look attractive, but with less of a flight to quality demand than in prior weeks. US Treasuries led a flattening in the curve with rates rising 5 basis points for 2 year yields and falling by 11 basis points in the 30 year spot. The municipal market benchmark rates didn’t see as much flattening with rates unchanged for the 2 year and a decrease of just 6 basis points in the 30 year rate; leaving ratios still attractive for municipal and crossover buyers.
$10 Billion on Tap
It seems like municipal traders are all getting back into the swing of things post vacation break with investment banks bringing one of the heaviest issuance calendars of the year so far. On tap, is close to $10 billion in bond sales this week. Two of the larger municipal bond new issuance deals that will be pricing this week include over $1 billion for the New York State Dormitory Authority Sales Tax program and almost $700 million for the City and County of Honolulu Wastewater Senior Lien tranche, led by Bank of America. By and large it seems that municipal bonds with a dedicated pledged revenue stream are becoming more in vogue for buy and hold owners looking to diversify away from ad valorem tax exposure. For instance, the Wastewater system in Honolulu provides wastewater services for almost 82% of the City and County residents, with debt service payments coming from dedicated net revenues of the wastewater system. With a recovering economy, unemployment at 3.6% and hotel occupancy at peak levels, the demand for this necessary service is strong. Further strength comes from over 3.2x debt service coverage for senior lien debt, coupled with over 1,000 days of cash on hand.
The Bottom Line
Understanding underlying credit quality and owning sticky assets such as individual municipal bonds should be part of every investor’s diversified portfolio. By understanding the security structure and credit quality of what you are buying, knowledgeable investors can reach for yield in a low yield environment. Owning individual bonds versus an ETF allows investors to avoid price swings that can come from international markets and their ripple effects.