Bonds

As a result of the continuing crisis in the banking sector, bond yields fell even further early Wednesday with municipals continuing to follow U.S. Treasuries in a flight to quality as market volatility persists.

UST yields fell 44 basis points on the two-year, now yielding 3.799%, and 26 basis points at 10 years, yielding 3.409%, as of 10 a.m. Triple-A benchmarks were bumped two to six basis points, depending on the scale, as of 10 a.m.

“Banks are some of the largest holders of munis, even though their appetite for the asset class deteriorated after the tax reform of 2017, which dramatically decreased corporate taxes, making tax-exempts less appetizing (a lot of banks, especially regionals, got more involved in taxable munis),” said Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel.

Nevertheless, in the past several years, “bank municipal holdings have remained stable in the $600 billion range — this includes both bonds and direct loans to municipalities — making them the third largest group of muni holders after direct retail/separately managed accounts and mutual funds.”

The past several days have been extremely turbulent. Following Credit Suisse’s announcement that it had discovered “material weaknesses” in its financial reporting procedures for 2022 and 2021, the bank’s shares dropped sharply early on Tuesday, reaching an all-time low. This comes on the heels of Silicon Valley Bank and later Signature Bank being “shut down by regulators within a matter of days, and prior to that, Silvergate Bank shut down its operations,” Barclays strategists said.

“Aside from market volatility and a flight to quality that caused a significant rally in U.S. Treasuries and actually helped muni total returns, the main question for investors recently has been: will we see bank selling of municipals that exerts pressure on the market, and what kind of market effects could occur,” they said.

Barclays’ strategists ”expect pressure on banks to persist, but the fallout for the overall industry appears limited.”

They said they “would not be surprised to see some muni bond selling pressure from mid-sized banking institutions looking to shore up their liquidity; meanwhile, [globally systemically importantly banks] are unlikely to sell and, if anything, might add exposure if muni levels are attractive enough.”

Overall, they said, “banks were not aggressive buyers of the asset class in the past several quarters, and they might become net sellers, but to us, this would not be really a game changer.”

The market volatility of the past several days had a pronounced effect on the market and on munis, with two-year Treasuries “rallying more than 100 bp over the course of just a few days and even long-dated UST yields dropping 30-50 bp prior to [Tuesday]’s sell-off sparked by a stronger [consumer produce index] print,” they said.

Due to the financial market turbulence, Barclays’ strategists “think that a 50 bp hike is off the table next week and that the decision will be between a 25 bp hike or a pause.” They said, “Fed fund futures also adjusted rather dramatically — now only one hike is fully priced in, compared with four less than a week ago.”

Both taxable and tax-exempt munis were “quite rich going into the current market turbulence and had lagged the rally in Treasuries, making them somewhat more attractive,” they said. Except for the long end, “which is starting to look interesting with ratios in the mid-90s, we would not rush in and would prefer to wait for better entry point and add on weakness.”

Nevertheless, Barclays strategists said, “supportive technicals have not really changed, high-quality tax-exempts might benefit from the flight to quality, and supply has remained rather anemic.”

Muni taxable have come under pressure, but “compared with high-grade corporates (especially financials), municipals have done relatively well, as frequently happens in times of market stress — they outperformed the corporate index by about 16 bp in just a few days,” they said.

The spread differential between the two indexes is “currently the largest in several years, indicating that taxable muni spreads might continue to adjust higher in the medium term,” they said.

Barclays strategists “would not be surprised to see some selling by regional banks that have been aggressive buyers of taxable munis over the past several years.”

AAA scales
The ICE AAA yield curve was firmer: 2.66% (-5) in 2024 and 2.65% (-6) in 2025. The five-year was at 2.42% (-6), the 10-year was at 2.44% (-4) and the 30-year yield was at 3.44% (-6) at 10 a.m.

Bloomberg BVAL was firmer: 2.77% (-2) in 2024 and 2.68% (-3) in 2025. The five-year at 2.43% (-2), the 10-year at 2.41% (-3) and the 30-year at 3.40% (-2) at 10 a.m.

Treasuries rallied.

The two-year UST was yielding 3.799% (-44), the three-year was at 3.688% (-39), the five-year at 3.477% (-35), the seven-year at 3.472% (-30), the 10-year at 3.409% (-26), the 20-year at 3.752% (-17) and the 30-year Treasury was yielding 3.614% (-17) at 10 a.m.

Primary to come:
A $485.7 million sale of gas project revenue bonds is planned by the Black Belt Energy Gas District. The revenue bonds are rated A1 by Moody’s and will be senior managed by Goldman, Sachs & Co.

The Los Angeles Department of Water and Power plans a $305.5 million sale of power system revenue bonds for Thursday. The Series A serial bonds mature from 2023-2024 and 2026-2032 and are being senior managed by Ramirez. The bonds are rated Aa2 by Moody’s, AA-minus by S&P, and AA by Fitch.

A $150 million sale of homeowner mortgage revenue bonds is planned for Thursday by the State of New York Mortgage Agency. The social bonds will consist of $115.8 million Series 250 non-AMT paper structured with term bonds in 2038, 2043, 2048, and 2053. Series 251 AMT paper will consist of $34.1 million maturing from 2023 to 2034 with a term bond in 2036.

The Idaho Housing & Finance Association will sell $115.2 million of single-family mortgage bonds in a two-pronged offering that is rated Aa1 by Moody’s. The $65.1 million Series A fixed-rated, non-AMT bonds mature serially from 2024 to 2035 with terms in 2038, 2043, 2048, and 2053, while Series B-1 consists of $50 million of fixed-rate taxable paper maturing serially from 2024 to 2035 with term bonds in 2038, 2041, and 2053. Barclays is the lead book runner.

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