Nuveen's Dan Close, Head of Municipals and Margot Kleinman, Director of Research, joins The Bond Buyer's Lynne Funk to explore how the high-yield muni market is expected to fare in the New Year, what sectors to watch and where opportunities lie.
Transcription:
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Lynne Funk (00:14):
Hello everyone and welcome to this Live Leaders Forum. I'm Lynne Funk with The Bond Buyer and I am delighted to welcome today Nuveen's Head of Municipals, Dan Close, and head of research. Margot Kleinman, welcome to you both.
Daniel Close (00:28):
Thank you, thank
Lynne Funk (00:29):
You. Thank you so much for joining us. We have a lot to cover today. I'll start off with giving a little bit about Nuveen, about our guests. Nuveen's $196 billion municipal platform includes 77 investment professionals with an average of 21 years of experience. Nuveen's Muni credit team is among the largest in the country. And I'll start off with Dan, who leads municipal fixed income, strategic direction and investment strategies and perspectives for Naveen. Dan serves as lead portfolio manager for high yield municipal strategies along with tax exempt and taxable muni strategies that include customized institutional portfolios, open-end funds, and closed-end funds. Prior to his current role in 2010, Dan helped establish and expand the platform as head of taxable munis. Dan began working at the investment industry in 1998 as an analyst at Bank of America Securities. So welcome Dan.
Daniel Close (01:27):
Thank you.
Lynne Funk (01:28):
And Margot is director of research for the municipal fixed income team at Nuveen. She's responsible for managing the muni research team and is also for conducting credit analysis and providing trade recommendations for credits in the charter school, higher education and private secondary education sectors. Prior to joining the firm in 2019, Margot was a muni credit analyst on the higher education and not-for-profit ratings team at Moody's, and she started in the investment industry in 2002. So welcome again to you both.
Margot Kleinman (01:59):
Thank you.
Lynne Funk (02:00):
And I would also like to point out that Dan and Margot and her team were recently awarded the Smiths All-Star Municipal Analyst Awards as the team of the year, and Margot was also named at the top Buy side, director of research. So congratulations on that. You two.
Well, thank you. Alright, so we have a lot to cover today. I'd like to get into it. I'd like to begin with the state of the muni market. The muni market ended the year with losses in December, pretty volatile month, but outperformed treasuries overall and high yield in particular dramatically outperformed investment grades. So let's kick it off with a quick look back and perhaps Dan, you can start with us. Where do you see the overall muni market performing in the near term? And that's particularly with a lot of uncertainty ahead from a macroeconomic and policy perspective.
Daniel Close (02:55):
Well, thank you for having us again and your new office space is incredible. Two weeks in, three weeks in
Lynne Funk (03:01):
Two or three. It's hard to remember at this point.
Daniel Close (03:03):
It feels like home. All new restaurants, everything around here. Thank you again for having us. But I think just starting out with the macro, we've really dusted off the old 2023 playbook of hire for longer. We have this period, especially with the jobs report on Friday, an important CPI print coming up on Wednesday that we think most of the total return for 2025 is going to come from coupon. It's not going to be this story we had in 24 where we thought we're going to have this great capital appreciation side. That still might be the case, but looking at the macro, we think more and more is going to come from the coupon side and not much from the capital appreciation and kind of setting up for this week. We have PPI came out today a little bit better than we anticipated. CPI comes out tomorrow.
(03:50):
I think all eyes are on that and with respect to that, we just continue that same theme of goods really rolling over. Housing is starting to get back to normal. All the Ford indicators are showing us that should be and continue to be a theme. And just the stickier components of looking at the components of, excuse me, the rollover that we're having with respect to services without the housing has begun to tick up a little bit. So we're closely watching those components. We're really closely watching what do goods do if we do have more tariffs. And so I think we're in a very good environment. I think the Fed is going to really take a step back and say we've got a hot economy or at least much better than anticipated inflation is being a little bit more sticky and persistent than anticipated. We still think we get to that two and a half percent core inflation, but it's just going to be a little bit tougher to get there.
(04:49):
So I think we're set up well for the year looking at fed fund futures before I came in down to one cut for the year all the way to that July 30th meeting. So that's been a pretty decent rerack of expectations. Only two cuts by the end of 2026. So it's just a little bit our narrative of the pre-ordained cuts, kind of like my New Year's resolution to run four times a week. It's kind of gotten thrown out the window pretty quick, just two weeks in. For the muni market in particular, we're setting up for I think a pretty good year. We've got $350 billion of coupons, sinkers of bonds maturing. That's always been very good. I think the January effect thus far has been horrible. We usually come into the year very geeked up with all the money that's going to come in and the January 1 coupon and that just hasn't happened.
(05:46):
That $350 billion that came in talking to brokers, it would appear that they were really set up towards the end of the year waiting for this. So we've really missed that January effect and you brought it up. I mean last year we had 1% or so for high grade munis, about 6% or so for high yield so far we're down a point and a quarter for high yield. We're down a point for high grade. So it just hasn't started out as we would've anticipated to start the year. And certainly with a Fed perhaps a little bit slower to cut than we would've anticipated. It does set up for a year where it is going to be more the coupon.
Lynne Funk (06:22):
Okay, but what about high yield in particular? It was massive outperformance last year from high grades. Is there anything else you anticipate? Anything we should be on the lookout in near future?
Daniel Close (06:35):
Yeah, we went back as far as data would show us on the spread between high yield and high grade, and there just has never been a year where we're had 500 basis points of difference. So it was a big confluence of factors where there was a number of flows coming into high yield. There were just not that many deals coming into the high yield space. I think as I look at the opportunity set, we are as of this morning plus 175 basis points to AAA munis, and that's a pretty decent starting point. If you look at the way that Margo and I invest for our portfolios, we're buying a lot of the smaller non-rated deals that have even wider spreads than that. So we do think there is room for compression there. We do think that we're set up again very good for high yield. If you look at high yield on a tax equivalent basis right now it's not and a half percent. And so you don't have to have a great year of capital appreciation to have a very good total return when you're starting out that high. And we were catching up beforehand, we are at the highest starting point to begin the year for municipals in 15 years. Since 2010.
Lynne Funk (07:44):
Yes, yes.
Daniel Close (07:45):
And that we looked back and said, well, 2010, that can't be 15 years, but it sure
Lynne Funk (07:50):
Is
Daniel Close (07:51):
Unfortunately. So at the highest point there. So we're at I think a very good starting point there. We are 120 points wider than our 20 year average as a starting point. So I think all this gets us to a very good starting point for this. Even if the Fed only makes one cut in 2025, it still makes cash much more expensive to hold. And I think those technicals that we saw last year in the high yield market do persist of generally pretty good inflows. We don't think that the high year calendar, it's going to be more than last year, but it's still not going to be enough to really supply the market what it's looking for. So I think set up very well for high yield. I don't think we're going to have the 500 basis point differential we did in performance from last year.
Margot Kleinman (08:36):
Okay. One more thing to add on that Lynne too. I think in the past when we've seen high yield spreads really widen out, it's been linked to contagion issues in the market. You think about Puerto Rico, think about Detroit or liquidity issues, and we're just not facing that right now. We have a very healthy environment. Credit conditions are robust. We don't have those sort of contagion issues to think about. So as Dan said, I think we are set up kind of going into the year for outperformance and high yield and cash. As Dan said, it's not very attractive to hold and there's about 6 trillion of cash still sitting on the sidelines kind of ready to go. So I think high-yield munis is shaping up and looking to be kind of one good place to invest and to put that cash to work.
Lynne Funk (09:27):
Excellent. So before a couple of weeks ago, we were talking about what we're going to talk about today, and of course I want to talk about credit and I would be remiss not to ask you about Los Angeles, the devastation that's happening there from your seat. What are you seeing? What are you hearing in terms of credit in California broadly and LA specifically?
Margot Kleinman (09:48):
Yeah, sure. Well, of course first, I mean it's just such an awful disaster and it's really horrifying and heartbreaking to see the pictures that we're all viewing and the videos and just the devastation that's happened has really been just unreal and surreal and kind of unbelievable. So of course our hearts go out to everyone in the LA area and just really hoping for things to get under control quickly. From a credit perspective, I mean, our team has been laser focused on California credit on Los Angeles area credits ever since the fires broke out. I think a couple thoughts to share. One is despite the terrible human tragedy, and of course devastation, municipal credit tends to hold up very well during natural disasters. So if you think about past disasters like Hurricane Katrina in 2005 or Superstorm Sandy that hit New York and New Jersey in 2012, huge catastrophic events.
(10:57):
Losses, Katrina over a hundred billion dollars, Sandy, over $70 billion worth of damage and the associated recovery. But in both of those cases, we did not see municipal payment defaults. We saw very minimal payment disruptions that were cured very quickly. In the case of Katrina, I think it was Moody's had downgraded 29 credits in the wake of that storm, Sandy, there were some credits placed on negative outlook, limited downgrade. So I think just drawing upon experiences with past very large natural disasters, investors can have confidence that muni credit is resilient and will remain a sound investment. So I guess that's really the backdrop from which we're looking at this. I mean, if you think about more granularly thinking about some of the credits in Los Angeles, LA County, Los Angeles Community College District, you're talking about a community college district with a 1.2 trillion tax base. You're talking about if you look at LA USD, these credits are huge.
(12:08):
I mean the tax bases, the communities they serve, the area is really huge. And so you have that dispersion of the effect across that. And since it's so large, it really can absorb from a credit perspective this kind of disaster. And also I would just say we're very focused on what is the state going to do. In the past, the state has come in and held school districts harmless for enrollment declines, so funded them at pre-disaster enrollment levels or backfilled property tax losses. So there's a lot that the state can do. Obviously FEMA is going to play a big part in the recovery. So there's a lot of resources that will be coming in to help these credits rebuild and recover. And we're going to be looking at how quickly is rebuilding happening, what are the long-term population effects of this? I mean, it's obviously a very desirable areas that have been hit by these fires.
(13:18):
So we have confidence that people will return to this area, people will rebuild. I was watching yesterday, there was an architect who was talking about building standards and some of the communities that were devastated had very old kind of wooden structures that were 50, 60 years old when people are going to look to rebuild the look to rebuild homes that are and businesses that are more fireproof. So these are the types of things that we're sort of at this point kind of waiting to see, but also really focused on. And I think the message is, and to our clients who have been really calling with many concerns about what's going to happen to these credits, are the credits going to fall off a cliff? Are there going to be defaults? I think we can confidently say that in the vast, vast, vast majority of cases, we expect credit to be resilient.
Lynne Funk (14:09):
Right. And these are high grade credits generally in Los Angeles. You bring up such an interesting point about the infrastructure itself and resilient infrastructure I think is something that the Bond Buyer has been covering a lot and it's just going to be a big focus going forward. And this is another way to look at how do we rebuild maybe smarter and
Margot Kleinman (14:29):
Yeah, absolutely. And I think Munis have a big role to play in climate adaptation and mitigation as we're seeing more and more of these types of large wildfires or large storms across the country and in municipalities, state and local governments are really on the front line of mitigating those disasters, managing those disasters and building to be resilient through those disasters. And so I think we'll also see that as a theme with issuance in terms of when we're thinking about supply. You need more supply I think, in the muni market, and I expect to see more supply in the muni market to address some of these issues.
Daniel Close (15:12):
And Lynne, if I could shameless plug, but we do have a white paper on our website that goes through a lot of what Margot had described as far as credit characteristics, what we expect going forward, what we're looking most closely for in our credit. And I do think to borrow from Margo's points, we probably will see more issuance for this adaptation for natural disasters. I think we've had such a stagnant market that's grown on a cumulative basis 5% over the last 15, 16 years. I think those on the front line of these natural disasters are going to have to go in and have these mitigation efforts. Talking to Margo before we went on stage here, spots like Miami, Florida going in and developing and right now investing in technology to pump the streets with seawater if it comes into downtown Miami or seismic retrofits for hospitals in California to make sure they could withstand earthquakes.
(16:14):
So it's happening, but we just think that that pace is probably, it has to increase. And I think again, to Margo's point, the most cost effective way to get any type of infrastructure done is the meeting market. So we do think that all roads are going to go through the meeting market in order to do that. And I think it is going to be a change in our marketplace, especially the coastal region in the southeast part of the country in California. We'll see this increase in issuance. And I think whenever I hear increase in issuance, I think it's a bad technical, it's going to lead to credit deterioration, but there's a lot of mitigating factors that we think that if there is additional issuance, it doesn't necessarily mean deteriorating credit or it doesn't necessarily mean bad, just I think part of our marketplace on a go forward basis.
Lynne Funk (17:04):
Okay, excellent. So why don't we actually, let's talk about supply and we'll kind of move over after supply to some demand components in this market. But 2024 was a record year of issuance in the municipal market over 507 billion. Some in the industry think that the market actually needs a trillion annually. I'm curious to hear what, and when you think about some of the things that are happening like LA maybe a trillion's, not all that a wild figure. Can you talk about what are you thinking for 2025? Have you all thought about supply expectations for this market? You want me to start
Margot Kleinman (17:47):
Off with this one?
Daniel Close (17:47):
Yeah, I could just at least start narrowly. So we put out in our Outlook piece, we had five themes for 2025, and one of them is the supply, I mean record supply this year. We anticipate that that will continue in this year in 2024, excuse me, was record 25, just there was so many projects that were delayed in 22 and 23, cost of steel, cost of labor, airport issuance, ground to a halt. You're seeing that all coming back right now. And I think that combination of even though rates are higher, they're at least more predictable. I think the inflation part has largely subsided. So we anticipate from a top line view, 500 billion in issuance. And I think you look at that number, and again, that's another big number, but there's 350 billion of recycled money coming in through our marketplace of, again, coupons and maturing bonds. So I think it's very manageable, but elevated again for 25.
Margot Kleinman (18:44):
Yeah, I would just add in terms of supply drivers that we're thinking about, as Dan mentioned, you have inflation, which is huge. I mean, project costs, some project costs. I've seen quotes up 60% or I mean that's humongous for if you're thinking about, of course a large highly rated issuer can absorb something like that. But when you think about a charter school trying to build a facility, I mean that's really staggering in terms of that increase. So you have inflation driving part of it, you have pent up demand use of the pandemic era money. Now these borrowers don't have that cash anymore to self-fund capital and need to access the muni market. I think some other interesting things we're thinking about too are demand for data centers, how that will fuel muni issuance for electric utilities, for water utilities, you need a lot of power and a lot of water to fuel and cool these data centers and data center construction is I think projected to be up like 40%. So I think if you think about these different areas, plus the climate adaptation and mitigation that we've been talking about. So I think there are a lot of drivers really coming together to boost muni issuance certainly this year. And we expect over the near term
Lynne Funk (20:07):
The confluence of events. And I think that you're so correct with the 22 and 23 being sub 400 billion, that was a big backlog there
Margot Kleinman (20:16):
For sure. Absolutely. Absolutely. And I think on the high yield side, last year, high yield supply, I believe it was about 47 billion of high yield supply last year, which was at 75% from 2023. And so we think that will continue as well. If you think about what's fueling that in terms of charter schools and school choice and real estate deals and land secure deals, some of the non-rated smaller deals that Dan was talking that our team looks at very closely and drives a lot of our high yield investment thesis.
Daniel Close (20:53):
And piggybacking off of that, we fully anticipate last year it was more than three quarters of high yield deals came non-rated. So I think we're starting to get, it was a trend that's really been accelerating the last couple of years. But on average last year we saw 13 high yield deals every week. There were some weeks that we saw 25, 26 high yield deals. It was the full employment act for a high yield analyst. But we expect that trend to continue of these smaller non-rated deals coming. We just don't see on the high yield side, at least many of these beta, if you will, issuers coming with the very large headline type deals. We anticipate that it's going to be a lot more of these smaller non-rated deals, and we think that the high-yield market is going to continue to be dominated by those deals and not really the rated variety.
Lynne Funk (21:44):
Okay. Let's talk about the demand components. You are the investors here in this market. I'd like to start with just mutual funds generally. 2022 was a terrible year for mutual funds, 23, a little bit of a rebound last year, positive flows, but the real change is the SMA growth and EF growth. I'm just kind of curious about what do you think about mutual fund performance? Where do you see that working? And then how do you look at ET F and sma, particularly that growth?
Daniel Close (22:16):
I could speak to our experience where, and I think really industry-wide, we are seeing a very fast changing market where there is just so many more flows going into SMA and ETFs. I mean, if you are, a lot of financial advisors, we speak to, our individual investors just aren't really looking to put money into 40 ACT funds or at least pivoting away. It's, if it's not an ETF solution, there's not as much interest. And so our view is we'll just make every snow cone flavor possibly known. If you want an ETF, an SMA, an interval, a closed end fund and open end fund, we will use the same chassis of the biggest research team in order to go in and to offer whatever type of product offering is needed. But for our shop, we saw explosive growth in SMA. I mean, it just continues to be that individual investors want to own their own bonds, they want to have tax loss harvesting, they want to customize, they want to actually own the individual bonds rather than have a undivided interest in a unit trust on the ETF side, sorry, Lynne, another shameless plug.
(23:26):
But we are launching two active ETFs coming out January 21st, so just a couple of weeks away or a week away as the case may be. And we were just seeing this growth not just in passive ETFs, but active ETFs. And so I think there's still very much a place for FORTI ACT funds for the open-end fund structure. I think especially for high yield, this large diversified pool, we've got more than 3000 credits in our flagship high yield fund. So I think there's always going to be a very good place for mutual funds, but it's just a question in that we're what is their place and is there other alternatives that are going to grow bigger? And I certainly think our SMA platform, 50 billion, 50,000 accounts continues to have just our growth cycle on there just continues to grow in an exponential fashion. And I think on our ETF side as well, we're seeing a lot of growth on our passive side and we're also seeing growth that we anticipate on our active side. Okay.
Lynne Funk (24:32):
And also you mentioned interval funds. I'm curious about your interval fund as the last year performed well, growing in the industry at large. Talk about that a little for those maybe particularly for those who might not know what an interval fund is.
Daniel Close (24:46):
Sure. And an interval fund, it's an Twix fund. So ours in particular, we offer daily subscriptions, but quarterly liquidity. And so right now we have it set at about seven and a half percent that you would redeem out on a quarterly basis. You could of course adjust that over time as you choose. But I think an interval fund, in my view, in our view at least, it's more congruent with the underlying asset class. You've got municipals where you've seen just not as much DV one liquidity by broker dealers just not offering as much daily liquidity as you had 10 years, 15 pre dot franc.
(25:26):
And so to me at least it's a vehicle that I think is a little bit more, again, congruent with the underlying asset class. You have daily subscriptions quarterly redeems, and so we get to have less and we don't need to hold as much cash and we could hold more liquid names, so we could hold more concentrated names. And I think that's really helpful, especially for municipals. And we've seen our interval fund grow, we're just under a billion dollars now. We're looking at launching other interval funds on the high grade side, but for the mutual fund, or excuse me, for the municipal asset class, as we go in and sometimes take a step back and say, you do have to provide some of your own liquidity given that broker dealers are not going to look to step in front of the falling knife. There's just less liquidity post do fra. These vehicles I think fit very nicely. And for us at least, we're the largest provider of closed-end funds and we're finding a lot of evidence of fas who like the closed-end funds, but want to see the funds trading closer to the net asset value beginning to move over to the interval fund structure because halfway in between a closed end fund and an open-end fund as far as an AV and liquidity,
Margot Kleinman (26:45):
And I'll jump in and use Dan's words of a shameless plug, but I think in terms of when you think about these different products and how credit research comes into it, I think with the high yield interval fund, as Dan was mentioning, holding sort of less liquid names, a lot of that could be non-rated paper. And you need to really have the staff and expertise to be able to look through, parse through those documents, ensure that the bonds are properly secured, that you know what your collateral is, that you know what your covenants are, that you know what your rights and remedies are, especially when you're having bonds in a less liquid vehicle like that. And then I'll also say on the SMA side, typically our SMAs tend to be mostly geared toward high grade credits. So it's not uncommon to see a lot of aaa, AA high A rated credits in the SMAs.
(27:42):
And I think if you look at the trends in rating agency upgrades over the past few years, you see over the past few years, four to one, three to one upgrades to downgrades. You've had this migration of muni credit really upward over the past few years. And in some ways you can think of it as it's almost, there's a homogenization of muni credit. And so how as an SMA manager are you differentiating between this AA school district and that AA school district? And so what are the gradations there? There might be this big basket of aa, but then how do you go in and say, this one's a buying opportunity, this one might not be. And so that's kind of a lot of what our team spends time doing and looking at. I
Daniel Close (28:26):
Drive the team crazy. It's like there's 10 Texas PSF deals, and it's like force rank them. If I'm going to go in and buy two or three of 'em, what is it going to be and why? Because if everything is AAA or aa, you just have, the distribution is so narrow, especially with all the rating agency upgrades. How many years ago, Margo was that to movies, went in and wanted to make everything
Margot Kleinman (28:48):
Right, the shift to the global scale, that was probably 15 years ago. Also, it feels like just yesterday,
Daniel Close (28:57):
No math on this program. But we're seeing that, and I think that that push, it's really force ranking everything that we have. I mean, if you have similar deals, which one do you like the best and why? Because it is really getting a very narrow distribution.
Lynne Funk (29:13):
I think you have about six, I think large PSF deals this week.
Daniel Close (29:17):
Yeah, in the primary,
Lynne Funk (29:18):
Right. We ranked them already, yes. Okay. Well, Dan, you have a background in taxable munis. Let's chit chat about tax goals because I know it's primarily rate driven, whether issuers have a resurgence in taxables that we saw back in 2020 and 21 rates were ridiculously low back then it made sense for them. But in general, do you see any sort of uptick in taxable muni issuance in the coming year or just your thoughts about the taxable market generally?
Daniel Close (29:51):
Yeah, generally it's a shrinking market in that you saw it in 21, 22, more than a hundred billion issued. I think 21 was 130 billion, 22 was just over a hundred. That was primarily rate driven. But I think we're seeing a lot of things right now this year. I think depending on what numbers you're using, if you use corporate backed municipal issuers in that 35 to 40 billion range, but it was actually a negative year for the second year in a row because again, you count up all the coupons and the sinks and the maturing bonds, but there was a lot of tender activity this year. So when issuers issued in that 20, 21, 22 period, and you have two and 3% coupons for 50 year debt, even though there's nothing, any credit issues, that's still trading at 70, 75 cents. And if you're an issuer that has a large enough balance sheet, you could tender that for five, six points more than what the bonds are worth and retire your debt at a much lower rate.
(30:52):
So this year we did see that market shrink. I do think it is very much rate driven. So if have current tax loss continue and you could only pre-fund with taxable instruments, it is really going to be rate driven. But I think that, and the other component that really came to the fore this last year are the herps, the extra extraordinary redemption provision for Build America bonds. And we saw a number of issuers, primarily if you have lower coupon paper and if you have a shorter average life paper that was right in the middle of the strike zone and just breaking that down, the lower coupon paper, you just don't have as much of a subsidy. So a 8% coupon structure is going to have a lot more subsidy from the US Treasury than a 5% structure. And if you have a shorter average life, when you're defusing these bonds, your discount factor is much lower.
(31:51):
So we anticipate that if you have a rich, like we did at the beginning of 24 in the muni treasury ratio, especially on the short end, you're going to have more herbs. And I think that this market can potentially grow if you do have lower rates. But I think the other side of it, on the demand side, at least internationally, our experience is the FX rates and the cost to hedge for Japanese yen, for Korean wine. It just really has made it difficult for those buyers to want to get involved just given how expensive those hedging costs are.
Lynne Funk (32:30):
Interesting. So the foreign base, I believe it did grow in 2024 though, right?
Daniel Close (32:35):
Oh, it did. It did. But is
Lynne Funk (32:36):
That a tax exempt
Daniel Close (32:38):
Purchasing or, so our experience is if you are a dollar based foreign entity and you want to immunize liabilities, there is nothing better than using taxable immunities. And you've got this perverse credit curve where the farther out you go, the lower the spreads you have. So if you get out to 12, 13 years, you have these foreign insurance companies that want to immunize long-term liabilities, and you would think that you lend someone money for a longer period of time, you would get paid a wider spread. It's actually much less. Once you hit that 12 year part of the duration curve, it actually starts going down. And those are the Harvard, the Princetons, the Yales that are issuing century bonds that are issuing 50 year bonds. And those are actually tighter because there is such just an insatiable demand for long duration paper and paper in the muni market that's not going to see 2, 3, 5 notch downgrades.
(33:37):
You're not going to have default risk. It's going to still yield 50, 60, 80 basis points more than treasuries. So our demand profile has primarily been from Japanese insurance that has dollar based liabilities, some in Europe, some in Korea, some in Taiwan. But if you look at Japan, if you are hedging, it's right now, give or take four point a quarter, you could get five and a half percent. You pay four point a quarter. That's kind of where JBS are banging around right now. So it doesn't really pay if you're hedging your currency risk to do this, but if you have dollar based liabilities or you're in Europe where it's a hundred fifty, a hundred seventy five basis points to hedge, it does make sense. So I think it does grow talking to issuers, I don't think there's much of a bid to do another program where the US Treasury repays them, fool me once with the sequestration and subsidy cuts. But we do think that there's interest, and I think our taxable muni book will continue to grow in 25. It's just more for those specific insurance companies that don't have to hedge.
Lynne Funk (34:50):
Okay. So let's talk about dc. Let's jump into that Now. I'm very curious. I mean, it's crystal ball, it's really not. I don't even know what to say about it. It's hard to read. It's hard to read. But I guess this industry is concerned, has concerns about a dilution of the tax exemption and elimination. You all hosted a webinar on policy, what your thoughts are, I guess I'm curious. The first question I'd ask, what happens if the muni market would lose the tax exemption from your seats?
Margot Kleinman (35:30):
I think in our view, it's very unlikely that the muni market is going to lose its tax exemption. I mean, if you think about all that we've been talking about today with the infrastructure needs and the most efficient cost effective way for state and local governments to borrow is through the muni market also. I mean, just think about all of the thousands and thousands of unique small muni issuers. I mean, how would a charter school really borrow in the taxable market or a small school district or a small rural hospital? Not only would it be much more expensive, but you also could see different borrowing structures. We've thought about maybe you would see more pooled financings or more state driven financing
Lynne Funk (36:14):
SRF.
Margot Kleinman (36:14):
Right, exactly. But then that really, if you think about it, I mean that really diminishes local control so much, which is not necessarily, I think what the current or the incoming administration is really all about. I mean in terms of their view on local control versus everything being more state control or federal control. So I think we think that there's a lot of headwinds, I think, to eliminating immunity tax exempt. I think that as many have read about, many have talked about, I think if there are carve outs, maybe you could see it for some of the private activity bonds like universities or hospitals. So maybe that's where they would go with it. But increasingly, I think we have confidence that the muni tax exemption is really going to stay in place.
Lynne Funk (37:07):
Yes, I have not heard that it's going to be eliminated. I'm trying to say that that's going to happen. I guess it just was interesting to think about in terms of the taxable universe and what kind of demand would be out there for the taxable municipals and given the low risk profile of this market, it's definitely an interesting thing to think about.
Margot Kleinman (37:30):
Yeah, I think it's a really interesting thing to think about. And I think if you think about some of the larger issuers that have already issued in the taxable market, you see that there is certainly a market and demand for those issuances. And I think it's, when you think about some of the smaller issuances that it seems a little bit tougher to figure out how that would be navigated.
Daniel Close (37:55):
And I think that's a great point. Just thinking that through the deals that really struggle on the taxable meaning side are really the smaller deals. I mean, that's where we make the most hay with our clients is we pitch it as we're going to be able to buy the 20 million deal that no one else is going to look at from the research side. But if you look at the amount of deals that are coming that are smaller, I think there's a really material price differential that you don't see the tax exempt side. There is some differential between the small and the larger, but it's just so much more on the taxable market given the buyer base. Anyone that's in Tokyo or Dusseldorf is going to know CalGas and it's going to know Harvard and Princeton, but it's not going to know a small joint power issue in authority in southeast Ohio. And so I think it would be really detrimental to those smaller issuers. And Margot and I have been working with our lobbyists and just going in and having that discussion and making sure that those on the hill know if the exemption does go away, here's the cost funding, your own high school giving up autonomy, going into some bond bank program are all things that I think really run counter to what the incoming administration and the incoming Congress would like.
Lynne Funk (39:18):
Right. And if you think about what the definition of fiscal federalism is, it probably is the muni market, right? Yes,
Daniel Close (39:23):
That's exactly right.
Margot Kleinman (39:24):
Absolutely.
Lynne Funk (39:26):
Was there anything else that you're looking at in Washington at this point in terms of expectations there, or
Margot Kleinman (39:33):
We've done a lot of work in thinking through what Republican control in Washington might mean for muni credit. I think broad based. I think that most muni issuers, I don't think we'll be, we don't think be materially impacted by Republican control, but there are a few sectors that stand out to us where maybe there could be more impact. So if you think about education, so of course higher education comes to mind. There's been a lot in the headlines about potentially taxing endowments and how that would play out and what that would look like. Certainly talk about rolling back some of the student loan relief, which would impact demand for higher education. So that's something we're keeping a close eye on. And then also school choice initiatives. A lot of school choices really driven at the state level, but certainly the incoming administration appears to be very, very supportive of expansion of school choice. And so that additional support, how does that play out in terms of not only more charter schools, but more universal voucher programs. And that can impact local school districts, local K 12 school districts as well. So that's something that we're keeping a close eye on. In terms of healthcare.
(40:54):
Will there be any changes to some of the governmental payer programs, Medicare, Medicaid? I saw an article yesterday that of a list of potential pay fors for the TCJA extension were being circulated around Washington, and there were a few related to Medicaid tweaks to the Medicaid program. And so what does that look like going forward? Are private insurers more involved in administration of those governmental programs? And then our smaller hospitals able to really negotiate and compete on rates the same way that the larger hospitals are. So that's another sector we're keeping a close eye on. And then I'd say lastly, utilities. So when you think about environmental regulation, just water utilities, for example, like the pfas, a forever chemicals and mandated capital upgrades to address that issue. Well, if you have looser regulation and there aren't as many mandated capital upgrades, maybe that's good for credit, but maybe not good for the people drinking the water. And so those are the three sectors that are really top of mind that we're thinking about as the administration changes over next week. I
Lynne Funk (42:09):
Know next week. Yeah, just curious, would a rollback of PS or even the higher edge, would that increase high yield supply in any way?
Margot Kleinman (42:21):
I think that talk of increased talk of losing the muni tax exemption is likely to move supply forward. That's what we've really been thinking about this year. Although in talking to bankers in the field, we haven't heard that that's really on issuers radars yet. So that might be a good omen for the future. Maybe it won't happen.
Lynne Funk (42:49):
Is there anything that you both would actually leave the issuers who are watching and listening with in terms of what you're looking for?
Margot Kleinman (42:59):
Better disclosure, more frequent disclosure, more frequent disclosure, more consistent disclosure, more investor outreach. I think there are some distribu in our market that do a great job of all of those things. And so that's wonderful and very helpful as investors. But I think the muni market is known for sometimes not the best, most timely disclosure. And so definitely as credit analysts, that's something that we are very focused on.
Daniel Close (43:32):
Yeah, I think just in a jar, when you're asking about the muni exemption, I mean, if issuers have the most to lose, if the exemption does go away, I mean your cost of capital building a new high school goes from 30 million to 50 million overnight without the exemption. So we've had a lot of discussions with issuers that if we go in and lobby Capitol Hill, we're not as sympathetic as a local school district that does it or local water authority that does it. So issuers we really think have the most at risk, and they probably have congresspeople that are going to listen most to them about the exemption. So on my short wishlist would be just talk to your local representative and make sure that they understand the importance of the muni exemption in infrastructure needs and building local infrastructure. And I think that message really carries a lot more weight and resonates more than us going in and talking about the exemption, those local issuers. I think it's much more helpful.
Lynne Funk (44:36):
Yeah, I'm up to mind too that I don't actually see some small issuers even being able to access the taxable market whatsoever. But in any case, this move went very fast. So thank you. Wow. I could ask you many more questions and to our audience, if we missed a question, hopefully we'll get back to you. Thank you both so much for coming in and joining me today. It was a great conversation. Lots more to discuss. So we'll keep this going. We love hearing from the buy side. So glad you were able to join us here. Thank you everyone for joining and from the bonfire. We'll see you soon. Thank you. Thank you.
