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Muni Bond Liquidity Set To Shift From Feast To Famine In August

Tyler Durden's picture





 

Despite the 'idiosyncratic' stresses in California (and elsewhere) the reach-for-'safe'-yield has maintained a strong bid for Munis in the last few weeks (on both a spread and yield basis). As Citi's George Friedlander notes, the last week alone saw 15-20bps compression in the mid- to long-end of the Muni curve - notably outperforming the longer-end of the Treasury curve. New issues have been oversubscribed and snapped as much as 20bps on the break. The reason is simple - 'all-time record' total redemptions (maturing and called bonds) - which left net issuance negative and a strong tendency for certain types of investors to put cash back to work as soon as it is received. However, this flood of 'technical' liquidity from reinvestment faces a rather sudden cliff around the start of August when expected net issuance will turn aggressively positive relative to redemptions. Given the constant refinancings and a lack of maturing reinvestment, Freiedlander expects "the muni market to struggle to absorb [the heavy calendar] after August 1 - and slightly earlier if participants begin to discount this shift", which will only push refinancing costs higher for issuers coming to market.

 

George Friedlander, Citigroup: Will the Muni market be held to ransom to slowing bond redemptions?

 

We believe that the strong rally resulted from a number of factors including:

  • The ongoing powerful bond call/maturity peak which runs from June 1 though August 1, as shown in Figure 4. Note that redemptions occurring on the first of a given month are shown as if they occur in the prior month. More about this below.
  • A strong tendency among certain types of investors is to put cash back to work as it is received. In particular, this has increased demand from bond funds and separately managed accounts. In both of these sectors, proceeds from redemptions tend to be put back to work rather quickly because cash that lies fallow at near-zero yields affects yields reported to investors. Bond funds in particular tend to hold on to high-coupon paper purchased when yields were higher as long as they can, in order to maintain reported yields. Then when those bonds are called, they have cash to invest. This pattern, combined with the massive amount of bonds being called as shown in the table, has led to bond funds being participants in new issues at a multiple of the $800 million — $1 billion that has been flowing into bond funds (4-week moving average of all funds) over the past two months.
  • A calendar that remains solid, but is not nearly back to June levels. June saw roughly $44 billion in issuance, a rate of roughly $10 billion per week. Now,issuance appears to be in the $5 1/2-$7 billion range, at least for now.
  • The "hole" in primary and secondary supply created by the 4th of July week hiatus. New issuance was close to zero for that week, and we suspect that a number of dealers attempted to reduce secondary market inventory as well, in order to avoid taking market risk when markets were virtually closed.
  • Better price discovery as new issuance returned. The muni market has a tendency to underperform its fundamentals when price discovery becomes difficult, as it was during the holiday week; and
  • Quite simply, the tug of the ongoing Treasury rally, which put yields on 10-year and 30-year paper at new closing lows for this long down cycle.

What Happens When the Redemption Music Stops?

Historically, redemptions have always clustered around coupon payment dates, in a three-month on/three month off cycle, around the months when coupon payments are at their highest: December 1, January 1, and February 1 and then June 1, July 1, and August 1. In the intervening months, redemptions from bond calls and maturities drop sharply.

Muni Bond Call and Maturity Patterns

 

As we show in the chart above, the magnitude of total redemptions from maturities on bond calls spiked beginning in May (which includes June 1), and stayed high for the next two months. Over that three-month period, net new issuance remains substantially negative, despite a strong pickup in new issue supply. After that, the typical dry spell begins, with total redemptions dropping from the $48–$50 billion range to roughly $21 billion in August (minus the August 1 proceeds, which show in the prior month in all cases). We anticipate that the subsequent two months will be no better, although data are not yet available. As a consequence, net new issuance turns substantially positive despite an expected modest decline in gross supply. More importantly:

  • The importance of redemptions as a source of demand for new issues has never been higher, with total redemptions during the current peak three-month period at levels we believe to be an all-time record by a wide amount. A big spike in current and near-current refundings during the current low-rate environment has contributed heavily to this pattern.
  • We expect total redemptions to stay sharply lower for the next three months as they always do in the three-month period after August 1. 
  • We thus expect the investor sectors that tend to put cash back to work quickly as bonds are redeemed — funds, SMAs, and some direct retail — to have far less cash to put to work until the next up-cycle in redemptions begins, which is on December 1.

These two patterns, in our view, are likely to create a new challenge for the muni market if new issuance stays high, as we anticipate. New issue volume is being held at very high levels by current and near-current refundings (in a cycle that we expect to last until at least 2015 unless muni yields spike higher to a degree that seems unlikely). As a consequence, net new supply should move well into positive territory for the period August–October, before turning negative again as redemptions spike. At the same time, of course, the sectors that typically pour cash back into the market as redemptions spike will have far less new cash to put to work.

The bottom line of all this is that we expect the muni market to struggle to absorb a continuing heavy calendar beginning at some point after August 1, and possibly slightly earlier if participants begin to discount this shift. There is, of course, both bad news and good news in this. The bad news is that valuations of existing holdings could come under pressure, and issuers could face a somewhat higher cost of financing. The good news is that the large number of investors who have become increasingly frustrated by the continuing decline in muni yields may experience a respite from that decline, and possibly even a reversal of the drop in credit spreads between gilt-edged and upper-medium-quality paper noted above. In any event, we believe that investors should be on the lookout for better values once the drop in redemptions begins in earnest.

 


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Tue, 07/17/2012 - 22:19 | Link to Comment Robot Traders Mom
Robot Traders Mom's picture

Some of these names, like Sacramento pension obligations, are so fucking overvalued, it is unbelievable.

 

I swear to God we are living in an insane asylum some days...

Tue, 07/17/2012 - 22:24 | Link to Comment markmotive
markmotive's picture

As David Stockman previously said: 

"If the Fed doesn't keep printing, it's game over"
Tue, 07/17/2012 - 22:48 | Link to Comment The Monkey
The Monkey's picture

And if they do keep printing, it's still game over. Bigger top, bigger glut, greater delays in needed fiscal action.

The only questions related to Fed action at this point are the date the market finally tops out and the amount of distance between the ceiling and the floor. The greater the printing, the more monumental the downside.

Wed, 07/18/2012 - 00:16 | Link to Comment phyuckyiu
phyuckyiu's picture

All of my Cali muni bonds are being called as we speak. Very ominous.

Tue, 07/17/2012 - 22:33 | Link to Comment The Monkey
The Monkey's picture

The downside to suppressed volatility is obvious when growth slows. Munis are trading at a massive premium, junk is expensive, agency REITs are trading above book (I saw one issue go the market with a secondary a couple weeks ago, and after dropping in-line to the secondary price, it was trading rich within a couple of days). Many of the risk adjusted prices on dividend bearing close-end funds are nuts.

Add to that the steady purchase of dividend payers, even those with questionable or decling balance sheets, various vulnerabilities, etc.

Investors are acting as if these issues are nearly risk free with reason. Bernanke said if an investor looked at the price of a treasury, they may instead decide to purchase a corporate bond. This is a deliberate effort to get investors of all stripes to take risk; consequences be damned.

Tue, 07/17/2012 - 22:55 | Link to Comment Michael
Michael's picture

Top story on Drudge;

Arpaio: Obama birth record 'definitely fraudulent'

http://www.drudgereport.com/

More videos here;

http://www.teapartypowerhour.com/videos

 

Here's something inspirational you may enjoy;

Humanity is on the Brink of Something Amazing

http://www.youtube.com/watch?v=suOds5C4DI8&feature=youtu.be

Tue, 07/17/2012 - 22:29 | Link to Comment TahoeBilly2012
TahoeBilly2012's picture

What do you know abour SacaTomatoes pension obligations, do tell!

Tue, 07/17/2012 - 22:29 | Link to Comment disabledvet
disabledvet's picture

"this is not the debt you're looking for. move along." all i see on the highway isn't highway work but tar. infrastructure bank indeed....of course "there's goes job creation." if it were me i'd be in full on "use it or lose" mode at the Transportation Department.

Tue, 07/17/2012 - 22:40 | Link to Comment q99x2
q99x2's picture

Just tell me when we are under Marshall law so I can open my special order from eFoods Direct. I know which container I'm going to open first.

Tue, 07/17/2012 - 22:52 | Link to Comment holdbuysell
holdbuysell's picture

So that explains why muni bond sellers catering to the high net worth individuals have been on TV commericals lately advertising to the general masses.

Tue, 07/17/2012 - 23:13 | Link to Comment The Monkey
The Monkey's picture

No shit. The Fed was a big actor in setting up the conditions for the first depression, stomping on the gas in the face of recession in 1928.

The Fed has a choice to make, and they will be making it in an election year.

Tue, 07/17/2012 - 23:00 | Link to Comment q99x2
q99x2's picture

Hugh Hendry on: Bad things are going to happen. I happened to notice his 650 million fund from last year now states: 800 million fund.

http://www.cnbc.com/id/48218372

 

 

Wed, 07/18/2012 - 01:17 | Link to Comment otto skorzeny
otto skorzeny's picture

some Obama-worshipping commie D-bag poster to that article was pissing and moaning about Hugh's mansions and his yacht. The guy has earned every penny though wise investing. and he's about to get alot richer with his Asian investing/hedges

Tue, 07/17/2012 - 23:33 | Link to Comment Not Too Important
Not Too Important's picture

Famine in August? More than you know.

Take a good look at this chart:

http://enenews.com/study-all-western-east-coast-covered-airborne-particles-march-20-model-shows-canada-based-solely-reactor-1-explosion-photo

That mass of radiation has spread across the Northern Hemisphere. Of interest here is the mid-West and the drought. Look closely at these heat maps:

http://www.zerohedge.com/news/us-climate-update-warmest-12-months-record

Notice any similarities? We have an inner-atmosphere radiation belt spreading across the entire Northern Hemisphere, spreading cancer and heart disease. The trapped heat is killing off our crops and most likely the cause of the very unusual flooding rains we're seeing this time of year. No crops, no food – radioactive or not.

 

From Enenews.com:

"A relationship between drought and radiation occurred to me this morning after reading the headline.

I did some research and found that the relationship has been argued before, although it is hard to find in the scientific studies of radiation because most of those address nuclear war, which would cause more dust in the atmosphere.
=========

"Earthquakes and Nuclear Testing" by Dr. Gary Whiteford. Paper presented to the Second International Conference on the United Nations and World Peace, Seattle, Washington,
14 April 1989
http://www.orgonelab.org/UnusualNuclearEffects.pdf

[excerpt from the article on a previous study]:

The Spring 1992 issue of Journal of Orgonomy (1) carried a paper by James DeMeo describing research undertaken in 1990-1991 on the California drought, with a "Special Note on Underground Nuclear Testing and the Oakland Wildfires" that bears repeating here:

Weather Response to Nuclear Testing

In prior articles, I discussed a possible connection between underground nuclear bomb testing in Nevada to weather changes in the Western US.(2) A graph was published showing changes in 500 mb pressure over Nevada and Montana in 1990, with a generalized association with nuclear tests. Nuclear testing appeared to have increased atmospheric pressure in the upper atmosphere, a possible factor in the expansion of high-pressure drought conditions in the West.

[end excerpt]"

Here's a list of countries that are the largest importers of American grains:

http://en.rian.ru/infographics/20100812/160171412.html

If you want to make a killing in this dysfunctional market, bet big on the grains - corn, wheat and soybeans. Then short to the max all those areas that are the largest grain importers, such as Mexico, the ME, South Korea and Japan - especially the ME and Japan. The food riots that started the Arab Spring are going to flare up much worse than they did before.

Those warships in the Gulf are not just there for Iran and Syria. The food shortages are going to cause civil wars, and some of our allies, such as Egypt (well, the military at least) might need US help.

We're in for a long fall, folks, and it isn't going to get better. The radiation in the atmosphere will last for another 10,000 years, but there's enough radiation on the ground now to make most of the world's crops into genetic freaks in a decade or less.

I wish you all well. There might be a 'moral' aversion to gambling on food and food riots, but you can bet the Primary Dealers and BBA banks are betting big on this. Something about 'investing when there's blood in the streets'. Well, here it comes. Hedge accordingly.

Wed, 07/18/2012 - 04:46 | Link to Comment Skateboarder
Skateboarder's picture

Food is sacred. Betting on it is wrong, even if it is GMOd up the ass, radioactive, or whatever. And remember that you're not even betting on real food but just the idea of food. Fucking parasitic thoughts...

Let the evildoers hedge their way to victory. However futile, I will make the best out of my middle-class salary to prepare for the end.

Fri, 07/27/2012 - 22:31 | Link to Comment White.Star.Line
White.Star.Line's picture

Excellent response.

To capitalize on misery is an almost sure victory for material gain, but destruction for the soul.

You obviously got some soul.

Wed, 07/18/2012 - 07:20 | Link to Comment New_Meat
New_Meat's picture

And Whitney gets validated, as we all knew she would. - Ned

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