A Look at the Demand Side of the Equation

Transcription:

Christopher Brigati (00:08):

Good morning. Very excited to be here. I think we've got an interesting discussion to be had here. My name is Chris Brigati. I'm a Director of Strategic Initiatives and Fixed Income Research at SWBC. Fairly new to that role. It's a nebulous enough title. I think that people are wondering what I'm doing here, but I've had a long career in the municipal market, both the buy side and the sell side, so kind of understanding those two different dynamics within the market leaves me to kind of have the opportunity to be here with these auspicious gentlemen. I think we've got really good talking points. We've got some very high quality discussion to be had and I'll let them introduce themselves.

Sean Carney (00:48):

Great. Good Morning. Good morning. There we go. My name is Sean Carney and I've been at BlackRock for going on 17 years. My entire working career has been in municipal bonds. I came to BlackRock in 2007 as a separately managed account or private client trader. I've held several different roles there, but most recently as CIO of our Municipal Fund Business and Head of Municipal Strategy.

David Blair (01:27):

Good Morning. My name is David Blair. I am a Portfolio Manager, Managing Director at Nuveen. I'm actually based in Newport Beach, California, so enjoy the comments on California this morning. Most of my team is actually based in Chicago, but I'm in the west coast. I've spent the last 28 years of my career at Nuveen and PIMCO. Most of that time has been in credit research and in portfolio management and currently I managed primarily SMA portfolios as well as a couple of active ETFs.

Christopher Brigati (02:09):

All right. Let's jump right into it. I think what we're going to first talk about is very high level in terms of what is the current state, can we frame the market both general interest rates but as well as we can dig down maybe a little bit into municipal market to understand where we stand relative to historical norms?

Sean Carney (02:28):

Sure. I can start and feel free to jump in, David. I think framing the environment, obviously we're in a higher for longer interest rate environment. Look no further than the most recent non-farm payroll report coupled with CPI retail sales yesterday. I mean it wasn't long ago that we came into this year where the market was pricing in six interest rate cuts for the year. The Fed had had three and I wouldn't be surprised if when we get to the June meeting the Fed backs one of the dots out and looks to potentially go one or two times here in 2024.

(03:10):

The data has been very supportive of a fundamentally strong economy and even one that has shown some signs of inflation picking back up. I don't envy Chair Powell for what he has to do here. I do think there is a sense that the Fed would like to go in the back half of this year. I do think they realize that high interest rates while good for investors, you're clipping a greater form of income, higher coupon for a longer period of time. It does have different results on different portions of the economy. High earners continue to consume, continue to spend on many things. Consumption is up, experiences are up. However, there's a disproportional amount that it takes from the wallet of lower income earners and I think the Fed realizes this, so the back half of the year will be very interesting. Mind you we're also in an election year, which makes things a bit trickier over the last four rate hiking cycles.

(04:12):

It has taken on average 326 days for the Fed to go from their last hike to the first cut. Once we have achieved a peak in rates, if we can agree that we achieved a peak in rates in October of last year at a 5% treasury tenure, that puts the first cut in mid-September of this year. However, with rates moving the way that they have this week, I think we could potentially challenge whether we have touched peak rates or not. I saw the 10 year at a 4 65 this morning and data continues to press that up. I think we're about 75 basis points higher on the year. The shape of the curve I think is important. Treasury curve is inverted by, call it 30 basis points twos to thirties. However, the muni curve has about 75 basis points of positive slope. That's meaningful because at least there's some term premium as you extend duration, there's added risk added reward that I think is important as well. Had anyone told us coming into this year that almost all of the interest rate cuts would be backed out of the market, treasury rates would be higher by 75 and Q1 issuance would be up by 30 plus percent. I think we'd all believe Munis would would've had a pretty poor outcome given where ratios were coming into the year. But that said, that has not been the case. Munis have held in quite well and that's the demand side of the equation.

David Blair (05:39):

I think Sean summed that up pretty well and I think we're largely in agreement in terms of the outlook for what the Fed will be doing this year. Our firm's view is we previously were viewing it as three cuts and it's now down to two. There is a risk it goes to. One thing I should note is that I think what's particularly different about this cycle and every investor tries to look at past cycles to try to understand patterns and try to project forward is that the models really haven't been working. Of course there's been a lot of errors in terms looking over the last few years. Very few people have been right much of the time. There's a lot of humility now and that's just because we've come out of COVID and there's been a dramatic change in inflation. Then the Fed had to be aggressive and now we're slowly transitioning out of that.

(06:36):

But in terms of modeling out how that occurs, the timing of which that occurs, it's incredibly difficult and I think when we look back over the last couple of years, there's been constant projections of the pace at which we move out of that cycle back into a more normal cycle with lower inflation and it's constantly been revised and extended out. Pardon me, and I think that's what's happening again now. It's sort of like two steps forward, one step back, we had a tremendous rally in the fourth quarter when it became apparent that the Fed was going to start cutting this year and from a point where rates were really at the peak for last year, we had backed up a lot in the previous two months. So tremendous rally. It was really the best fourth quarter that Munis had since the 1980s, yet we still entered this year even after that with the highest yield since 2011 to begin a year.

(07:38):

But ratios were kind of tight. I think the expectations for this first quarter were that this past first quarter were that we needed a little bit of consolidation in the market, so to speak, where yields would probably need to go back up. It's just happened a lot more than we thought and it's been led by treasuries in this view that inflation's stickier and the fed while the direction it looks like we're going down in inflation and the Fed will be cutting still. The pace has just been revised and I think if you have that view, which we do, this is a tremendous investment opportunity because yields have increased so much this year in Munis, they're across the curve up 50 to 60 basis points even on the inside of two years, over 70 basis points. And people were sort of complaining a couple months ago that yields had gone too far and it rallied hardwell here's the opportunity to get in. So that's our view.

Christopher Brigati (08:43):

I think a few interesting points there too with regard to the inversion of the yield curve, the shape of the yield curve, notably for the treasury market, the historical context is that an inverted yield curve has preceded every recession. Dating back in history doesn't mean it's a predictor, but the fact that it has preceded the actual recessions and there was one false start, so the fact that we've had to maintained a long period of this inverted treasury curve is of interest in usually the recession starts approximately 17 months after the inversion. We're looking at about somewhere in the range of 13, 14 months at this point in time. So from the average there's still some room to run and the discussion, we had some of those talks yesterday with regard to soft landing, hard landing, no landing. I think there's a lot of debate on every side of that and that's of interest to me specifically and I'm thoughtful of that.

(09:36):

The other point I wanted to bring in is the inverted municipal curve, two to 10 years inverted municipals. It's an unusual occurrence. It doesn't normally happen nor does it maintain to the degree it has, and so we're kind of in uncharted territory and I think that shapes some of the demand side of the equation and we'll get into that a little bit as well. But the next discussion point is as asset managers, what changes have you seen to the demand side of the equation with regard to different aspects of the business, the growth of SMAs mutual funds and ETFs becoming ETFs specifically becoming much more prevalent, and how has that shifted the dynamic for demand within your spaces?

David Blair (10:16):

Yeah, there's been a tremendous growth, consistent growth in SMAs that's across the industry. Certainly within our business we've been investing a lot in that business for some time to increase efficiencies because all products are competitive on fees, but particularly SMAs and so there's I think a lot of investors who are investing in these like the ability to control your tax outcomes when you invest in a mutual fund or ETF or mutual fund in particular that's dealing with outflows and having to sell bonds, but you have that with ETFs as well. There's tax consequences that are beyond your control that you share in with the other shareholders. So with SMA, you own all the bonds individually, you can customize that, so there's a lot of particularly very wealthy investors that have been putting a lot of money into these and I think that'll continue to grow.

(11:14):

One thing that was different just a few years ago when rates were so low, yields on SMAs were below 1% and it was hard to justify as an investor going into that with fees to what they were. That's definitely changed and I think as particularly as the Fed starts to cut, I expect to see that area continue to grow. ETFs is another area and I should say SMAs now are the biggest investment product out there. Mutual funds are still large, they're about 19% of the investor base, but SMAs, according to the study I saw, they're about 21%. Mutual funds are still very important, but they've been slowly shrinking. A lot of that's been going into ETFs now, which is still a small part of the market, but tremendous growth there. It's a lower fee product, it's very easy to transact in those and we're finding that those assets there are pretty sticky and there's sort of trends. If you look at other asset classes that are now have a much bigger ETF component, munis are sort of tracking with the the early growth of those asset classes, so pretty optimistic that we're going to see a lot more going into ETFs going forward.

Sean Carney (12:29):

I would agree there's been a product demand shift, which ultimately to me screams that there's a different experience that muni investors are looking for. In a world where mutual fund yields were significantly higher than what you could build in a zero interest rate world, the majority of money coming in was in mutual funds, but as rates begin to rise and you can build a separately managed account where there's a lot of transparency, there's a lot of customization that goes along with it, whether it be from a duration standpoint or a credit standpoint, I think people really like to open their statements and be able to see CUSIP by CUSIP level. So that transparency has been a real shift. The one thing I will say is that when we do get into an interest rate environment where rates are again falling, just think back to Q4 of last year where we had a significant rally.

(13:26):

I think a large portion of the 10 billion that mutual funds have seen in this year are a result of what took place in Q4. Right? Flows in the muni market tend to be a reflection of past performance. I think that as we get into an environment, yes, there will certainly be those that look to the SMA community continue to build, but I think you'll also see a shift back towards mutual funds given that as that spread begins to narrow, there are opportunities in mutual funds that offer a bit more yield than you can in the SMA space itself. I think the ETF world has really garnered a lot of attention, whether it be an active or passive ETFs, the minimal fees on ETFs, the amount of users that are using them for different reasons, there are portions of the year we're getting invested in SMA is very difficult. You can park cash and ETFs, you can use it in many different fashions, but the liquidity I think is the premium that people are interested in. So it'll be interesting to watch what happens as rates begin to fall again. But for now, the SMA community, I think by our measure in 2022 and 2023, while mutual funds lost 160 billion, SMAs and ETFs brought in about 145 billion, so they have grown in support, that's for sure.

Christopher Brigati (14:52):

Yeah, I think the growth of the SMAs in the past couple of years has been quite astounding, but it also speaks to the broader growth and wealth in the country and I think for municipal bonds, that's a really good dynamic to have. Obviously people, investors, individual investors specifically enjoy the tax benefits of the tax exempt status of the bonds. I've seen and heard many times in my career investors doing things that don't necessarily make pure economic sense, but if they can avoid a tax and a tax that they'd rather not pay by legally investing in something like municipal bonds, they really tend to gravitate towards it and they'll put their money into the asset class, and so the fact that there's greater wealth in the country, it affords the growth of SMAs as an investing tool and it really allows the customization, as David mentioned, allows you to really engage the market directly in a different way and you can control your own fate and destiny with and when and how you take gains or take losses in the asset and that really helps investors. Expanding the lens out though, how does the current interest rate environment shape the way you approach your investing? With regard to how do you position the portfolios now, how do you look for credit quality and what types of credits and or structures are you really focusing on?

Sean Carney (16:16):

I think a couple things come to mind. I think patience is being rewarded as we sit here in a higher interest rate environment. Income is replacing negative price performance, so if we look at the broad Bloomberg Barclays Municipal Bond Index, it's down one and a quarter percent on the price side of the equation, you're down two and a half percent, but on the income or coupon side, you're up one and a quarter. So this is about income replacing negative price movements until we get to a place where we feel comfortable that rates have or are peak. The value in the muni market today is about a couple of things. It's rates over ratios. I think it's also taxable equivalent yields. If we take a look at an A rated municipal bond, common spirit came two weeks ago in a large headline deal, the 10 year bond had a taxable equivalent yield of 5 60, 30 year bond, seven and a half percent.

(17:10):

I think this is what people are looking at in the market as far as positioning. I think a barbell position has been very popular. I know obviously we're not the only one with a barbell, but the reason it's popular, and trust me, it tests you often sitting in front of clients telling them that your neutral duration, because let's be honest, they want to hear that you're whipping it around and these different things that you're doing, but you just can't do it in portfolios. You're not being paid to do it right now. So being neutral, you can take on your front end duration where you're getting yield without duration in munis, think things like prepaid tax bonds or just short duration bonds and you can marry that with where you are getting paid out on the longer end with a bit more attractive muni treasury ratio, decent liquidity, so on.

(18:03):

It's really kind of avoiding somewhat of that belly of the curve where the SMAs and the ETFs, which are not as price sensitive, have really pulled rates and ratios down. So I think just a little different strategy, being a little bit more patient from a credit quality standpoint. We have an up in quality bias, just don't think you're overly paid to go down in the risk spectrum of the risk stack right here. However, we can talk about high yield munis. I think that's a different animal, but up in quality barbell strategy right here, taking advantage of where all in interest rates are.

David Blair (18:39):

Yeah, I think that the inversion of the yield curve in munis is something that I'm not sure that we've ever seen it certainly to this magnitude. If you look at yields in one year going out to 10 years, it's about negative 70. So the 10 year is about 70. For AAA, it's about 70 basis points lower in yield than the short end, and then if you go from the 10 year out to the 30 year, it's well over a hundred basis points steepening, and so it's really attractive out there. So it depends on the strategy. If you're talking about an intermediate strategy, the barbell is an attractive approach where you're investing a portion in short bonds, great yield, there's probably not, pardon me, a lot of price appreciation potential, but you're getting that further out the curve. So the other part of the barbell is investing it where you're getting the roll down on the steep curve, attractive yields and with a duration stance that's along to the benchmark, which that's based on our view of where rates are going over the next 12 to 18 months.

(19:50):

Certainly going through a backup right now, but it's very hard to time that right as we were talking about just a lot of uncertainty. So we're not about trying to time that perfectly. It's more about directionality and where we view rates going. So where they're going, so taking advantage of the curve, the inverted curve, slightly longer and duration credit spreads have tightened. Credit really outperformed in the first quarter, particularly high yield, and so spreads are on the tighter end of where they've been historically, a little like for example, high yield is I believe if you look at the high yield index, Bloomberg high yield index over AAA yields, it's about 215 basis points. Now. The average over the longer term last 1520 years has been more like 240 basis points, but they've gotten a lot lower than that, as low as a hundred in 2007 and just as recently as 2018 through 200. So we think that with a positive economic outlook, we think that recession risk is pretty low. We think there's going to be a gradual slowing in growth, but it's almost like a Goldilocks environment with inflation being a little sticky but coming down. And so we feel comfortable in that type of environment with most issuers having strong balance sheets to be continuing to overweight credit.

(21:29):

And we do like high yield in particular with SMAs now those are predominantly single A and higher, so we're trying to add to a exposure there, but it is naturally a high quality type of product really there. Where you're adding value is the duration and curve and sort of the bond structure. It's interesting with one area where there's opportunity now where people have been shunning this area, selling it a lot, is that inverted part of the curve, particularly five to 10 in maturity. A lot of strategies that are longer in nature have been selling that still are and trying to extend duration out and they just can't do enough of that. It's cheapened up that part of the curve and so there are certain opportunities to find bonds that have been, they're out for the bid trying to be sold. You can get them for a good price either with a short maturity or a long maturity with a short call.

(22:28):

So besides the barbell, there's opportunities in that five to 10 range a little bit more selectively. I'll quickly just talk about sectors. Credit quality is generally very strong. Upgrades have outpaced downgrades for several years now by four to one. It's in the first quarter. I think it was more around two or three to one, and we expect it to be more balanced going forward, but still a good environment for issuers From a credit standpoint, the fundamentals are very good with spread tightening. It's a matter of where you find the opportunities. There's still good opportunities in healthcare, which has had some challenges over the last few years post covid, and that's very much a bottoms up process with our research team to identify the issuers where there's real value. Some of the university areas, higher education, there's some really under pressure there because of demographics, but there's some that you can find good universities that are at wider spreads now. So those are a couple of examples where you can still find wider yields, but it's being selective.

Christopher Brigati (23:43):

The inversion of the yield curve kind of creates that little area of the curve where it's less attractive. So the barbell strategy that both of you had discussed kind of lends to the question of are you having any challenges with regard to getting bonds in the portions of the curve where you do have the demand? How difficult is it and how do you go about managing through that?

Sean Carney (24:04):

I think that we're both lucky to sit at firms that are large players in the muni market and get good allocations, but it's a good point. I mean the average deal in the market is five times oversubscribed. If you're down the credit curve or have something unique in your deal that's closer to double digits. So yeah, access to bonds has not been the easiest. I think that you're just repetitively in any and all deals that your credit research team really wants you putting in the portfolios. And then I think to David's point, you have to scour the secondary market as well. Looking at bid wanteds that are out there can be another way to source bonds in these portfolios. Obviously you prefer to do it in the primary when and where you can for a couple reasons around price, transparency, allocations, liquidity, so on, but the secondary market, we'll certainly have some gems out there for you to be able to place in as well.

David Blair (25:02):

Yeah, there's been, the municipal market has barely grown. You go back to 2009 to today, I think it's maybe 5% larger in terms of the bonds outstanding and you look at corporates, I think it's 80% larger, something to that effect. It's astounding how the fixed income markets have grown with the exception of munis and the demand for Munis continues to be very strong and it's growing now certainly with the Fed outlook and coming off of such low yields where they're attractive now. So that has to be taken into consideration when you're looking at ratios. Ratios are pretty tight right now, but I think Munis have shown resilience through the bad CPI report last week. They barely sold off and treasuries, the reels were flying higher, and so I think I mentioned this because it's just a symptom of the fact that bonds are hard to find and you're seeing deals consistently oversubscribed.

(26:06):

When the market was selling off recently, I think this was right the day of the CPI report, there are a couple new issue deals where particularly in that 12 to 20 year part of the range, which is the sweet spot for a lot of strategies, it's very steep and everyone wants those bonds. There were deals that were coming that day that were multi like five to six times oversubscribed on a day where CPI was hot and treasuries were selling off. So I think that's just a reflection of that part of the curve being probably the hottest in demand right now, but I'd say there's consistent demand across the curve inside 10 years. Even though it's inverted, there's still demand there. A lot of SMA strategies are one to 10 and they've got consistent demand on that part of the curve too. So very well bid across the curve and it's just a symptom of the strong technicals where there's not enough muni bonds around.

Christopher Brigati (27:03):

In both of your roles, you tend to spend a decent amount of time in front of the advisors that are directly dealing with the clients. So what kind of feedback, what are you hearing from the advisors and ultimately the clients with regard to how they're approaching their portfolios, where their demands lies and how they think about municipal bonds in general?

David Blair (27:22):

Yeah, a lot of advisors are still sitting in short-term treasuries to some extent. I can't blame them when you're earning over 5% and you're going through a period right now where they missed out on some price appreciation a few months ago. But for a lot of these investors, they're not really looking to take too much risk with munis. Their risk is being taken elsewhere often in risk assets, and so they're happy to clip the coupon and not take any price risk and have, if you look last year, even in a year where Munis ended up doing pretty well, I run some of bespoke strategies that are very short that are for one big client where they run some that are three year duration and then one that is a one year duration. And the one year duration outperformed the three year duration last year, even in a year when you would've thought the three year on the face of it would've done better, but it's just the strong carry you get from that yield that really translates into an attractive return.

(28:28):

So a lot of investors are still in that and I think we're having discussions with some of them, getting them into longer bonds, longer strategies, because there's reinvestment risks. The fed will begin to cut, we think, and while it might be only one or two times this year, it's likely to be more next year, and there is the risk that growth does tend to end up slowing more than expected. So if that does happen, you're going to see a big rally in the market and we want to just make sure some of those investors who are over allocated to the short end are considering those risks. And so that's the primary conversation that I think we're having today.

Sean Carney (29:12):

Yeah, I think to David's point, a lot of conversations with advisors is about where are there opportunities in stepping out of cash and cash plus products? I mean, you have to have the conversation about building durable alpha in portfolios. Building durable duration sitting in the front end has been a winning strategy, but once the fed begins to cut, the market will begin to read in how many cuts are coming and when that happens, front end yields will begin to fall. Reinvestment risk to David's point is real. So helping them understand the shape of the curve where there is an opportunity to step out of cash and cash like products and build some durable duration into portfolios, I think is one conversation. The other conversations are usually around concerns, concerns about interest rates and where they may be going, concerns about credit quality. David made the point that last year upgrades outpaced downgrades four to one.

(30:11):

That could moderate a bit, but I think it speaks well to the underlying health of these economies. On the maybe less good news, a lot of the Covid era funds, fiscal stimulus has been spent and we're really seeing a divergence between wealth reliant states and consumption states. You heard Glenn speak about this earlier this morning, but median state revenues were down 1% in December of 2023 using the 12 month rolling calendar. Not a big deal. What is a big deal is that those states that rely on consumption, sales tax, think Texas, Tennessee, Florida, Washington, so on, they all had very positive experiences on the other side of the ledger. You look at California and New York, their revenues were down 16 and 6% respectively. So just seeing a bit of divergence in credit quality and exactly where to go. I think other conversations are what's the value of munis in the portfolio today given where I can get yield elsewhere, you have to value the fact that munis have less overall volatility to them, they're a higher credit quality than what you're buying on the taxable side. Yeah, and they have a negative correlation to equity and equity like risk because heading into an election. So I think those are kind of the main conversations with advisors right now.

Christopher Brigati (31:34):

Changing course a little bit with the departure of Citi as a player in the municipal market and quite a significant one for decades, what effects, if any, are you seeing and do you have any concerns with regard to liquidity in the overall market and or how other people, other institutional broker dealers might pick up some of that slack?

Sean Carney (32:00):

I can take that there is a human element to this that should not be underappreciated. So from that side, and there were a lot of people's lives changed by the decision that Citi made to that. I mean to date, there hasn't been a great change in the muni market for a couple of reasons. I think a lot of the producers have landed elsewhere. Maybe they've had to get up and move, but we've seen a lot of them show up in other seats, which is a good thing. They're participants you want in the market, very knowledgeable, good experience, but we also haven't had an event that really presses on liquidity in the market in quite some time and I think that's maybe when we'll find a bit more stress. I would say that the muni market is very good at adapting and overcoming. Sure, it may take a bit of an adjustment in ratios in our market, but that renter of the muni market, that crossover buyer is always out there looking. So in an event that we were to have one less large player in the market and begin to bleed over into liquidity, I do think you'd see the market adapt to it.

David Blair (33:08):

Yeah, I would agree with that. I really haven't. There was a concern initially that it would be more noticeable with Citi out and I think it's been very marginal, the effect, it is almost unnoticeable, but let's wait and see until we get that event where it's risk off and everyone's buying wants to sell everything but treasuries and that's when a lot of the intermediaries all pull back. And so in that kind of event when everyone's pulling back and not really intermediating markets, that marginal player can make a difference. So it's something to be, we will love to see what that looks like when that event happens. Again,

Sean Carney (33:50):

I will say listen to David. We talked about the demand side of the equation, how it shifted towards SMAs, and one of the good things about that is when we get some type of market illiquidity or some type of a market event, it won't be the SMA community that's looking to all of the sudden sell. These are very sticky assets. These are portfolios that are put together with great thought. It'd be more the portion of the market, maybe the ETF side. If you look at MUB that grew from 5 billion to 37 billion in quite a short period of time, those types of things can put pressure back on markets and you'll need those to step up and support that type of a market more so than you have to worry about what happens in SMAs and so on.

Christopher Brigati (34:34):

I think from the standpoint of SWBC, what our organization is doing in that space is helpful to potentially filling some of that gap. We're engaging more in the new issue market. We're engaging more in competitive and negotiated, but also our intent is to pick up some of the slack with regard to the secondary market, throw more balance sheet at it and be more involved to be that liquidity provider and warehouse bonds if and when needed as an appropriate tool. I think the challenge that we run into as was mentioned is those liquidity events and if you look back at what happened during COVID, I remember AAA, pre-funded bonds in five years traded at 400% of the comparable treasury, and that was purely because people sold what they could and you're essentially selling a municipal back treasury bond at 400% of the comparable treasury in that time period just because people were rushing to the exit at the same time.

(35:30):

And unfortunately no dealers were willing to stand in front of that freight train at the time. So again, if we do get a liquidity event, which at some point is arguably going to happen again, how do we weather through that storm as a business, as an organization, as an asset class is going to be telling. But I think enough people in the space have decided to step up and do what we're doing and try and be thoughtful about just maintaining an orderly flow of market and the buy-side participation in the bid wanted space. As Sean mentioned, looking to those spaces to be a regular liquidity provider as well has been helpful. So being thoughtful of that is important. One of the things that I also wanted to touch upon was Babs. I mean we've had some talk about the legislation and people questioning the refunding of Babs in that space. So do you have any thoughts or topics or discussion points about taxable in general, but Babs specifically?

David Blair (36:25):

Well, Babs issuance is probably going to be affected negatively by this until this all gets sorted out. I can't really predict what's going to happen, but from what I'm hearing, it sounds like we're not too confident that there's a case that the investors are pushing that they're going to win this with the BAB situation, but we'll have to see how that plays out in terms of refundings. I think that's one interesting aspect is we had a hundred billion dollars of issuance in the first quarter. It was pretty large. It was I think 25% above last years first quarter, and most of that was due to refundings and actually a portion of that was Babs. Without the Babs refundings, we'd still have a lot of refundings going on, so I don't think it's going to make a material difference in terms of issuance in the tax exempt market.

(37:27):

So that's really as a tax exempt, primarily a tax exempt investor, I'm focused on that. So we still see a year ahead with a healthy issuance, at least 400 billion, it could be higher if rates revert back lower and are sustained down there, I think we'll see more refundings and more issuance coming. Still we need that because it looks like if you look at projections, they're around 400 billion for bonds that are going to be redeemed. So that's money coming back into the market. It needs bonds to buy, so we need more issuance. So that's more of an aside, but that's all I have really on Babs. I dunno if you

Sean Carney (38:06):

Have, I don't have a ton. I think that it adds to the underlying amount of bonds that could be issued throughout the year. I mean we've seen certain portions of our market demand fall. I think foreign investment continues to rise overall a smaller portion of the market than things like retail and so on, but these taxable bonds do feed into that foreign investment. Well, to David's point, I think we just have to wait and see what happens here. The sequestration cut into these bonds back in 2013. Here we are in 2024 talking about an extraordinary event. So just kind of questions whether it's an extraordinary event or the timing and the math works out better here and whether investors that invested in these are supposed to get taken out at an extraordinary redemption provision or at a May hall call, I think is kind of the question that's on the table. If nothing else, it just throws some sand in the gear of the timing of a couple of these deals, maybe slows things down and puts 'em in the back half of the year or in 2025. But I think that's how we think about it.

Christopher Brigati (39:11):

I think that the credit spreads and bands is relatively attractive. I've heard more and more people wanting to be into the taxable space simply because it's a decent alternative right now. It's a matter of getting those bonds, but if some of this demand is taken, some of the supply is taken out of the market as a result of some of these refundings, arguably that should help the overall performance of those bonds in general. So I am hearing a little bit more of talk in that space as well. What thoughts, what advice might you have for some of our issuer clients and friends out here in the audience with regard to how they can best create that supply and meet the demand with regard to when they're bringing deals?

Sean Carney (39:52):

I think that's a good question. I've always been of the notion that in credit markets, demand creates supply. So as we're seeing greater flows into the market or we're seeing better pockets of demand from different buyer bases, that's where demand will ultimately show. If you have a well-known credit to the market and you're coming at a time when cash is flush, I don't think there's really any advice that could be given. The deal will be five to seven times oversubscribed immediately. I think maybe for issuers that don't have that common name, that often comes, I think just appealing to the buyer base at a given time. Think of what has happened recently with prepaid gas bonds and we could begin to see an uptick of those. Now the earning season for the large banks is nearly behind us, but here's yield without duration, something that every portfolio manager was looking to put into portfolios over the past couple of years or unique structures, unique calls, a way to figure out how to make your billion dollar deal feel like a $500 million deal when it gets to the market because there were taxable and tax exempts, there were non calls, there were calls, there were just different structures like that.

(41:08):

I think being able to align what you're bringing to the market, also being unique coming at times when others just don't want to come or aren't willing to come. There's a great seasonality to municipal issuance, understanding that and hitting the market when others aren't coming. I think over the past three, four years, we've seen on Fed Weeks issuance falls from the prior week by almost 50%. I promise you. We're still all there looking to buy bonds even though it's a fed week. So be a bit unique in when you want to come. Make sure there's eyes on the deal.

David Blair (41:42):

That's a good point. I think there's weeks where we're always looking to buy. We've got cash, we're looking a little longer term. We're not necessarily trying to time markets, we're being mindful of the fed meeting, particularly buying in the secondary market, but if a new issue comes, it's an opportunity to get an allocation. Those weeks, there's very little issuance and there's something to consider. There's all different types of investors in the market who are focusing in different parts of the curve, so there's demand everywhere. But where I think the strongest demand is because both long-term and particularly intermediate strategies, which there's a lot of assets there where they're focused, is that part of the curve? That's 11 to 20 years out and calls that are nine to 10 years, the more current the call, so to speak, not so short, but nine to 10 years we're trying to get duration.

(42:39):

That's the challenge right now is investors are trying to extend portfolios and there's a challenge doing it as quickly as we want. When we see sort of the end of that tunnel where the fed eventually is going to start and just ahead of that, there should be a good market rally we think. So that's another point to consider. In terms of structure, I see some issuances come where it's mostly inside 10 years and there's, I'm sure particular reasons for the issuer doing that, but it's important to note a little further out the curve that the level of demand, that's where you see multiples in terms of over subscription. We see deals 10 times over or 15 times over in that part of the curve.

Christopher Brigati (43:26):

I think one of the things that I've seen in my career where there's been opportunity for structuring deals that has been unique and also adds value to the market and kind of creates its own demand is if an issuer comes with a bond that has a mandatory put structure, issuing a 20 or 30 year bond with a five-year mandatory put on it allows for better yield in that portion, the curve down there for the investor, but also kind of creates that shorter duration, which is kind of in demand now. And with the inversion of the yield curve, presently looking to a different structure to create some of that yield where there's less might add some value to the investors. And then another thought I've had is when structure has been such that a 10 year period, the coupon kicks up from a typical four or 5% coupon in this day and age to something like an 8% coupon back in the day, I remember seeing some of these structures and individual investors really liked that. It almost forced the issuer to have to call that bond at that point. They don't want to pay that 8% coupon at that point in time, but because of that uniqueness, it also created a little bit of better yield for the investor, but it kind of shortened the overall duration for the issuer as well. And so net there's ways for issuers to be creative and thoughtful in that process. So I think recognizing and understanding that is there's unique ways to approach this from every angle and finding that demand is important.

(44:51):

We've got a few minutes left if I have a few more questions, but if there's any questions from the audience, please step up to the mic while we're waiting for somebody to get brave there. Perhaps we can talk about, as you mentioned, the high yield market a little bit. What can we talk about with high yield for the demand of the market and where people see that?

David Blair (45:13):

Yeah, sure. High yield's an area of that you got particularly negatively affected when rates were going higher because a lot of the high yield products out there not only had credit exposure, but they had a lot of duration. So performance suffered, but we're now seeing very strong performance in high yield. I think there's a lot of opportunity there. When you look at muni high yield versus alternatives like corporate high yield, which is typically much shorter in duration, but tax equivalent yields are still very attractive. You consider risk, credit risk, the default experience is much lower. So when you adjust for that, yields are even more attractive. So spreads have tightened, and again, I think there's a demand level that is being reinforced by a view in the market that directionally we're going lower in rates and the volatility in the market I think is still there rate wise, but it seems to be lessening from what we saw the last couple of years.

(46:26):

I think particularly as we get closer to a fed cut, I think you're going to see more assets come into the market. So I think yields are going to be coming down. I think high yield will continue to be an area of focus of where you can get yield and credit. Research is incredibly important in this part of the market. So both of BlackRock and Ian have big credit teams. We're both big investors in this market. Sectors that have typically been the problem are more around nursing life care, some of the project finance, particularly for alternative energy. So there's certain things that you want to be really careful around and we are, but there's still outside of that, plenty of opportunities and a diversity of sectors diversified across this country that you can get good credit diversification investing there.

Sean Carney (47:21):

I think there's several places that you can go with high yield defaults continue to be episodic. However, that doesn't tell the entire story. High yield has often been more of a stock pickers market. Heavy reliance on the credit research team here at the end of the year, muni returns tend to be less about that slight tilt you might've had on in duration or in credit, but it's really the avoidance of those bonds that go from 1 0 8 to 70 or other scenarios. So really doing your homework. When I look at the IG portion of the muni market, I think about the income type returns. When I look at high yield, you're thinking about total returns. Over 60% of the high yield market is priced at a discount compared to about 80% of the IG market that's priced at a premium. So here's where you're looking for bonds that are either somewhat mispriced or waiting to rally due to their convexity buying bonds at $80 price, 85, 90, and watching them run to the coupon.

(48:26):

When we get a rate rally, maybe that's fueled by a Fed interest rate cut, who knows exactly what it's fueled by, but there's a lot of total return opportunity in high yield. We continue to favor high yield. We think it has a right place in portfolios, but managing that allocation across different products, it's not going to largely sit in SMAs, it's going to sit in mutual funds, whether they be open-end closed-end LP types of structures, high yield funds themselves. But I do agree we could see some more issuance there. I think it would be met with greater demand. I think there's a decent amount of demand looking for high yield with munis. Earlier we talked about the muni main index being off one and a quarter percent. The high yield muni index is actually positive on the year, and that's because that income has fully replaced that price. If we look around the world at what we can invest in treasuries off 3%, the US ags off 3% long treasuries off eight, corporate IG off three ish high yield munis continue to be positive and I think it speaks a lot to the underlying credit quality, the lack of fear there around defaults more just picking the right bonds in the right sectors. I see we're out of time, so I'll cut myself off.

Christopher Brigati (49:42):

There we go. Thank you. Thank you very much everybody. We appreciate your time.