Some municipal bonds backed by federal leases are trading at rock-bottom prices rare in the municipal market, attracting hedge funds and other crossover buyers.
The discounts come as
There's roughly $3 billion of bonds backed by leases from the GSA. The debt is traditionally taxable and often structured with large bullet maturities that will require refinancing, asset sale or lease renewal at the time of maturity to avoid default, according to Moody's Investors Service. About 60% of the bonds are rated BBB, according to Barclays, which put out a Feb. 20 report on the sector.
For investors who can tolerate the risk, the recent drop in prices is making the bonds appetizing, said Mikhail Foux, managing director at Barclays.
"It's a $3 billion sector and no one has paid close attention to it, [but now] the distressed levels have attracted a lot of people," Foux said. "We don't have much distress in the market, munis or corporate high yield, so I think that's why crossover investors are suddenly quite interested."
In its report, Barclays noted that bonds backed by a lease at the National Aeronautics and Space Administration's headquarters have been trading in the mid-50s, a level at which "we see value," the bank said.
On Feb. 10, Moody's downgraded the NASA-lease debt, which is named the Two Independence Hana OW federal lease revenue bond issue, to B2 from Ba2. The downgrade "reflects NASA's recent signals that it intends to downsize its headquarters office and consider new locations, decreasing the likelihood of full lease renewal in 2028 with terms that would enable successful refinancing of the large outstanding principal payment," Moody's said. "The downgrade also reflects emerging uncertainties in the GSA's general leasing strategies more broadly."
The bonds declined further after the downgrade. The bonds' most recent trade, on Feb. 20, saw a $3.8 million tranche sell for 53.125. That's down from 76 in September and 97 last February.
Foux notes that at $275 million, the NASA bonds represent one of the larger deal sizes in the sector. And its 6.145% coupon is higher than many other GSA coupons, he said.
"Clearly there is a lot of risk in the trades but we felt that at 50 cents it's interesting," Foux said.
The debt comes due in 2028, which means the government will keep paying — at minimum — for another three and a half years, Foux said.
The 6.145% annual coupon payments brings in another roughly 20 points, he noted. "If you buy at 50 and are protected for another 21, you're essentially at 30," he said. "So the talk is not that you'll get par" if the government ends the lease, "but will you get positive returns? At those prices it's becoming interesting."
Like Foux, James Pruskowski, chief investment officer at hedge fund 16Rock, noted the drop in prices brought in a wave of new buyers.
"But let's be clear, this is a policy-driven trade," Pruskowski said. "NASA's lease renewal is up in the air, caught in the crosswinds of shifting federal policies and a shaky D.C. office market," Pruskowski said.
"There's value on the table, but the real play hinges on whether policymakers bring clarity," he said, adding that the GSA's downsizing could take time "while the [NASA headquarters] building's prime location, strong bond security, and high odds of lease renewal make this a trade for the most opportunistic accounts.
"With so much debt outstanding, every trade will have an outsized impact, and original holders are unlikely to tolerate much more downside. New risks and opportunities are brewing in select corners of the muni market—federal lease-backed debt is certainly one of them," he said.
More than half of the GSA leases rated by Moody's have expirations or termination options before the end of 2028, and roughly 25% of GSA owned and leased space is in the Washington D.C. area, the ratings agency said.
