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Shifting Investor Demands
Participants:
Alexander Chilton
Managing Director, Head of Municipal SecuritiesMorgan Stanley
Sean Carney
Managing Director, CIO of Municipal Municipal Bond Funds, Head of Municipal StrategyBlackRock
Molly Shellhorn
Senior Research AnalystNuveen
Jamie Doffermyre
Head of Public Finance Syndicate and OriginationTruist Securities
John Murphy
Director, Head of Investor Relations ServicesPFM
Speaker 1 (00:00):
Well, we're not going to waste any time. We're going to focus on something that I'm sure everyone's going to have a lot of questions for this panel, especially as they finish. So be thinking about it. This is shifting investor demands. We've got the moderator, Alex Chilton, managing Director, head of Municipal Securities at Morgan Stanley, Sean Carney, chief Investment Officer, BlackRock, Molly Shehorn, senior Research Analyst at Nuveen. Jamie Dole Meyer, head of public finance syndication and origination at Truist. And John Murphy, director and head of PFMs, investor Relations Advisory Services. Thank you all for being here this morning and I'm sure this group's going to be ready to pepper you with some nice questions, especially after the market changes that we've seen the last few days. Thank
Alex Chilton (00:53):
You. We'll definitely leave some time for questions, but first thank you to the bond buyer, state of Texas, city of Austin for having us all. I was having dinner last night with bam. Thank you for hosting Sean McCarthy. And surprise, surprise, the conversation turned to Munis. I dunno if that's what we all expect, but we do talk about munis after work and during work and before work. And he was telling me that Munis were up on CNBC, that they had the ticker for the ETF Sean, that was probably yours. Probably M-U-B-M-U-B,
Sean Carney (01:21):
I'm sure. Yeah.
Alex Chilton (01:23):
MUB was up on the screens and the analysts that were on CNBC kept saying, well, Munis are not supposed to behave like this. And I told 'em that I was going to kick off our conversation with that because I don't think munis are supposed to behave like that. So I went back to my hotel afterwards and I did a little bit of research and I looked up all of the muni changes since 1981. Thank you to the fine people at MMD for having that information available to us. And the largest muni changes. The first three of them were in covid, increases in yield. The fourth was in 1981, the fifth was in Covid, and then the sixth and the seventh were Monday and Wednesday. I guess we're going to have to name this something and anyone have a good idea for what the market's going to call this these past three days on the panel. Mayhem, mayhem,
Molly Shellhorn (02:13):
Mayhem, tar tantrum.
Alex Chilton (02:16):
Yeah, I was thinking the tariff tumble or maybe the tariff Twitter tumble, something like that. But we've had two of the largest moves out of seven. And if you look at the data a little bit differently, this is actually if you add up the first three days, Monday, Tuesday, and Wednesday 90 basis points, that is the second largest move since we have data here in the muni market and that includes the eighties where munis were moving in oh five increments and not by one basis point. So we're going to start by going down the line and asking people what they thought about tax policy, but I'm going to change that up a little bit. So apologies to the panelists. If you don't like any of the questions, just pull your ear and I'll switch it up. But I'm curious, 90 basis points in the first three days latest updates is that munis are lower in yield by 45 basis points this morning, so higher by 45 on the week. Where do you think the week ends up? Let's just go down the line. Jamie, you're sitting next to me.
Jamie Doffermyre (03:10):
Yeah, so I mean, I feel like it was interesting. So yesterday morning you could definitely see the market where m and d could adjust by 30 basis points by the close, it should have been unchanged, right? So the hard part I think, and especially from a dealer seat, is you look at these changes throughout the day with somewhat of a static read and sometimes there's an update as much. So if we're getting back 45 today, I thought we'd get back 50. So I thought we'd get back 50 pretty quickly and would take probably a day or two to get that 50 back.
Alex Chilton (03:40):
Okay,
Jamie Doffermyre (03:41):
So if we're getting back all 45 today, I think we probably have another, I mean it works in seems like threes or days of threes when it downturn and upturn. So my guess is if we're getting 45 back today, we'll get another five to 10 tomorrow
Sean Carney (03:55):
And
Jamie Doffermyre (03:55):
Then the market will kind of reassess on Monday where we're at. Any other opinions?
Sean Carney (03:59):
No, I think Monday is important. I mean, we got very close to having some greater liquidity issues with taba and wines and things like that. If the slide continued yesterday's MMD move to Jamie's point, it shows some of the nuances in our market what it felt like at noon it did not feel like it for. So if we're going to get back a chunk of it today, I think we'll still see some buying into the weekend and then where we reset on Monday and we have to figure out what happens with the calendar. The calendar's been large, a lot of it went to the sidelines. How much of it comes back? The fact that a good amount of it went to the sidelines is incredibly helpful. It's a self-correcting mechanism within Munis. Demand creates supply when that demand curtailed. So did supply, which is healthy because had the supply continued to come, it would've said that issuers were much more concerned about potential future tax policy and would've just pressed on the market that much more. So it feels like we've got good footing. Let's see how far it goes from here.
Alex Chilton (04:50):
Well, I just think one of the interesting things is Monday you couldn't sell a bond if you wanted to. Tuesday, you couldn't sell a bond if you wanted to. Wednesday you couldn't sell a bond until one 30 and then you couldn't buy one. So I think there's a lot of questions here about the muni market and liquidity and what liquidity means to the muni market and that liquidity means to issuers. John, do you mind if I throw this one down to you? Sure. What do you think?
John Murphy (05:15):
The last couple of days have been paralyzing and to have this, and we spoke about it yesterday on the panel, I think it was Rob and Ron and Patty all talked about flexibility and having that flexibility and having a parameters resolution in place or whatever gives you that flexibility to enter the market in the most timely basis for yourself. If you're forced to come to the market and you have to come, you're stuck at the mercies of what happens this week from that standpoint. So if you have the ability to go to the sidelines and pull away and be part of that self-correcting mechanism in our market, then that behooves you to do so. And I think that's what a lot of folks have done, and we will readdress at the end of this week and next week to see where things are going to shake out if we have any more stability in our market.
Alex Chilton (05:58):
I mean, people keep talking about potential liquidity problems in the market, changes in composition of investor base. If you take a look at the numbers, 72% of munis are owned directly or indirectly by retail, and it's a big number and it's an important number because the presence of other institutions like banks and insurance companies as a marginal buyer. So their tax rates in 2017 during the last tax act changed from 35% to 21. So there's this mantra going through the muni market, which is the thing that matters the most is retail. What is going on with retail? What are they doing in the market? And I think that in the past three days, everyone has been looking to see what retail has been doing, but it's an interesting dynamic flipping from you can't find a bond, you can't sell a bond and you can't find a bond. I just want to dig into that a little bit more and see if anyone has thoughts because it seems like it's changed a little bit. I'm curious why has it changed and does it matter to issuers?
Jamie Doffermyre (06:56):
I have a lot of thoughts.
Alex Chilton (06:57):
Okay.
Jamie Doffermyre (06:59):
And part of is the background of my career starting at Merrill Lynch where retail was such a dominant force. And so talk about if we think about the makeup of our buyer base. So two trillions held by or 2 trillion by this is by the Federal Reserve data. So two trillions held directly. So that 2 trillion is held differently today than it was 10 years ago than it was 15 years ago. So if you think about the creation of the separate managed account, which has been I think driven in a number of different ways. If you're a big wirehouse, what are wirehouse try to do? They basically said, we don't want guys buying individual munis directly. We want fee-based business and we want professional managers for a whole host of reasons. That makes a lot of sense. So about 10 years ago, separate manager accounts probably held about 400 billion of these direct media holdings.
(07:52):
Now that today is about probably 800 billion or so. So if you think about what's been professionally managed in our market now 10 years ago it was about 30%. Now it's about 45, 50%. So what do professionals managers do? Rightly so in a market like this week, pretty patient, when the market's cutting 20 basis points a day, it's less about, okay, wow, we've hit attractive yield points. It's more about, oh wow, okay, this is what we're seeing. We're worried about liquidity, worried about this kind of continuing, worried about extension risk, we're worried about all these things. Then I think it pervades across where the market gets literally bit more defense than it would. And to your point of saying, okay, what's the ballast for that? Right? Obviously yield levels matter a great deal and for individual investors it does. So long fives, you get to long fives, we could sell a gazillion bonds to direct individuals. I think some of that happened, but then also the insurance companies and banks definitely step up. But again, there's liquidity gaps, right?
Alex Chilton (08:49):
Yeah, but talk to me about that from the context of the issuers. Why does that matter in an issuer?
Jamie Doffermyre (08:53):
Well, it doesn't matter. So think about if you're approaching a market where we were two weeks ago and we had ratios in 10 years at 65% and you had ratios out long about 82%. So what does that liquidity gap look like? So banks and insurance companies 10 years ago were probably 30. Their share of the market is like 25, 20 6% today is closer to 20%. That's about 200 billion worth of liquidity that they could or may, may not provide. So what all that means is to them to get involved in a meaningful way, they have to be much more attractive than sometimes what they think is more liquid counterparts. And that has everything to do with kind of that ratio move. And so what do we see? We see ratios going from 82 to 95 and you see insurance companies come in that I haven't seen in three or four years. I think they operate. It seems like these guys, it seems like they wait every 15 months or 18 months when we have some of this liquidity challenges, that's when they get invested in our market. And then to your point, issuance kind of goes away. It kind of self-corrects ratios come back down and then the market kind of churn along.
Sean Carney (10:01):
Alex, just to add real quick on liquidity itself, it shouldn't be lost. That pre-financial crisis, the broker dealer community held over 50 billion on his balance sheet
(10:11):
And that bottomed out at 6 billion in 2020. It's worked its way back up to, let's call it 20, but we've lost large players in the market and the amount of balance sheet being put out there for our asset classes has really shrunk. So it leaves more to do for the buy-side community. At the same time, when we have put instruments into the market where people get instant liquidity in SMAs, you don't see people while they're at work calling their financial advisor saying, why don't we sell a few of those CUSIPs that we hold? But if you own an ETF with instant liquidity, that just creates exactly what investors have wanted. So we just see a lot more bonds moving through the system and you've got to find a buyer, otherwise you just have gaps in liquidity like Jamie mentioned.
Jamie Doffermyre (10:54):
No, absolutely. I mean at Citigroup we used to carry 3 billion bonds, right? On a daily basis when it was a band, when we used to carry 3 billion bonds on a daily basis, probably aban, that's probably cut in half at Truist about a billion bonds. And so in a sense, if a lot of our major competitors have reduced, we've gone from basically zero to a billion in three years. It doesn't quite make up for the liquidity gap, but I think it's very, very solid point on liquidity and how the dealer community is facing because challenging, it's challenging to hedge, it's challenging to do all these things from a dealer side.
Alex Chilton (11:30):
Look, I like what you're talking about on the liquidity side. If you think about a tax rate of a bank of insurance company at 21% and you think about a tax rate of retail at somewhere around 35, 30 7%, right? That 15% difference times treasury yield somewhere in the 4% ballpark are about what the moves between Monday, Tuesday, Wednesday, and Thursday are that we saw, right? So when people say liquidity gap in the market, I think the reason why it matters to issuers is that when retail goes away for a period of time, it used to be that banks and insurance companies would come right in, but now there is 60 basis points of a gap, right? Between that and as Sean's talking about, dealers used to have 50 billion imbalances who actually looked it up the fed report as of right before this crisis was 11.
(12:22):
And I think to give a little bit of context, 11 billion bonds, we could argue what point in the curve they hold it in, but unhedged and in 90 basis point move that somewhere around $800 million of losses that were taken by the dealer community on those bonds in a period of three days. And if people wonder why 50 is gone to 10, it's because of that and it's because of banks having to shoulder those losses. So when we think about that, John, I'm curious when you think about that from an issuer standpoint, dealer balances, dealer supporting the market, where's your head at on that? Where do you think we're going?
John Murphy (13:01):
I mean, to be honest, I want to make sure a hundred percent of that liquidity is used when you're issuing my bonds as opposed to secondary market transactions. But I know that's not the case and we have been in the market when the market's rolling and it's good, it's a placement situation, there's no bonds left over, there's an oversubscription, there's a demand for it, and the market's operating in its usual kind of mode. But when you get to a point where the insurance companies don't come in or the banks aren't in and the 42 to 48 part of the curve has no subscription or the 32 has no subscription, you're expecting your underwriters to take that portion down within the scale that they wrote for you. And that's where I want to see that liquidity being spent and making sure that it's there for me in a week. We've had the last couple of days, there's nobody's going to underwrite in that spot. You want to step away. The self-correcting mechanism takes a lot longer than it should.
Alex Chilton (13:51):
Just talk to me about trends in that versus pre-financial crisis. How many participants, underwriters are there out there that you think could take down material balances like that? What are the trends that you're seeing in the market?
John Murphy (14:10):
From my experience, there's about five I'll Sean only anything different.
Sean Carney (14:17):
It doesn't feel like it's double digits for sure. I mean from the issuer standpoint, what's important is who's your end buyer? If the market feels good and you're selling to SMAs and ETFs, you're in the driver's seat. The first 15 years of the curve are going to be spoken for tenfold. If you're an IG deal, if you're high yield, it's going to be even greater. But when they step back either because of seasonals or because of just not a lot of cash there and you're pricing to more of a mutual fund or a crossover type of buyer, they're going to demand higher yields for sure. That cost of capital goes up overnight.
Alex Chilton (14:48):
So let's talk about that a little bit. I want to pull out the crystal ball here. I know Glen is talking about his crystal ball being clear and cloudy sometimes. I'm kind of curious what ours looks like right now, but I want to think about retail here for a second. I want to think about how retail is thinking about the muni market given the changes I want to talk about move some of the original intention of this panel back into the conversation about tax change with rates higher. Can retail take a material position here? Is tax change too scary? What I've been reading in the market is that there's three things that are out there. There's potential tax policy change, there's uncertainty with tariffs. And then the third one is that there's just general uncertainty and volatility in the muni market and it feels like even after the tightening today that we're okay priced for one of those, but maybe not all three. But I'm curious, as you all are looking at the markets, if you think that retail feels comfortable making an investment here in front of all that uncertainty or if they're just going to close their eyes and to the munis and just focus on the stock market,
Molly Shellhorn (15:50):
I can start there. Historically, retail has not responded well to shock and tends to overreact. I would not expect any significant moves ahead of anticipated tax policy. I think we really are going to have to wait until we have some certainty on what happens with the tax cut and jobs act policies. And until then, I don't think we're going to see. Then after we have certainty, then we'll see moves.
Alex Chilton (16:20):
Any other pins? Come on, Sean, you got to have one here for us. What do you think they're doing? How many assets do you have under management now?
Sean Carney (16:30):
185 billion,
Alex Chilton (16:31):
185
Sean Carney (16:32):
All so retail in general's chase's past performance, right? This past week has put a lot of uncertainty in the market in general, that cloud is not going away unless you have a high probability that there's going to be a tax change that's drastically going to disrupt the market. I think retail is really going to care about these yields and getting invested as we start to get on the backside of the issuance pop that we get in March and April. So SMAs in ETF buyers traditionally are not market timers. They're getting in, they're getting invested. They want to clip the coupon, earn the income throughout the year. I think that's what we will see once we get past this tumultuous period that we've been
Alex Chilton (17:12):
In. So I pulled a little bit of the data yesterday, we hit a record for the most number of trades ever in the municipal market. I think it was 112,000 trades. That's the highest since we've had data since 1995. I think it's really interesting. That is above the 10 year average of 42,000 trades. So someone is definitely paying attention and I think if I'm going to talk about positive things and good things that are going on in the market during this crisis volume was up, market volumes were somewhere in the 12 and a half billion. I think it's interesting to think of those market volumes in the context of how many bonds dealers own. So 12 and a half billion of volumes, 10 billion in dealer balances. So dealers don't even own one times day market volume, but stuff's trading and stuff's moving. So I'm curious where you all see opportunity right now in the market. What's interesting, what do you think people want to see in terms of issuance and see in terms of supply?
Jamie Doffermyre (18:19):
Yeah, I think everything's interesting, right? I mean I think that's a pretty bad answer, but I mean think obviously I take a little bit of different take from the dealer side, but I do feel like a lot of this noise, and I agree with ma, if we think about inflows into mutual funds and our professional managers, they haven't been overwhelming this year. They've been steady, but it haven't been overwhelming. I think it has a lot to do with the uncertainty and I think there's a lot uncertainty in market in the healthcare space and the higher ed space and it has a lot to do with federal funding. So I look at it and say, I mean yesterday the opportunity was obvious. I mean airports, toll roads, all trading well behind a 5% super, super interesting. That's not the case today, but still I think in the absolute yields for that type of credit qualities is immense. I think there's a lot of opportunity in the higher ed space because it's been kind of beaten down and I think there's a lot of interesting stories there, whether stuff has mortgages or there are different types of pledge. I also think there's the healthcare space is also very interesting. I think the spreads wide and quite a bit over the past week there. So I feel like it's probably, I don't think I have a great answer for you because I think everything right now is pretty interesting, but if you ask
Alex Chilton (19:33):
Me, I feel like the room loves to hear that, right?
Jamie Doffermyre (19:35):
Yeah. But I feel like if you think about two weeks ago I would say healthcare higher ed seemed really interesting to me. Toll roads, airports seemed really interest to me as four different sectors that I thought had a lot of value versus the generic market.
Sean Carney (19:49):
Alright
Jamie Doffermyre (19:50):
Sean,
Sean Carney (19:50):
There's good opportunity in the yield curve. CNBC loves to put up the treasury yield curve and exactly how flat it is at any given time. However, the muni curve because of our natural retail buyer in the first 12 to 15 years of the curve and then more of a synthetic buyer out long, kind of puts a kink in the curve and gives us the opportunity to have a lot more steepness. So you get paid for taking on duration in the muni market. There's term premium there. So right now I think most people are around neutral. If you talk to anybody before yesterday, everybody was short and now everybody wants to be long, but I think people are around their benchmarks given the massive amount of uncertainty that's out there. But there's more ways to get there. If you put on a barbell where you're invested in the first three, four years of the curve and then out 20 years on the curve, you can get yourself there, but you can pick up a lot more income. The muni market's unique in that if you go out 20 years on the curve, you pick up 95% of the steepness, but you only take on about 80% of the duration. I think that's a really good trade. Things like adding a MT transportation is a very good liquid sector within munis, but then adding a MT at an additional 60 70 basis points of spread I think is also a good opportunity in the market. Lemme
Alex Chilton (21:00):
Pause you real fast. I'm sure there's some A MT issuers in the audience. A MT is trading wider than pre 2017 when a T actually mattered. I think there's been a lot of questions around that as to what's going on with that. Why are am MT spread so high? Why when I call up my financial advisors and talk to them, A MT is always more of a challenging pitch. What's going on with that?
Sean Carney (21:25):
Yeah, maybe a MT is a little bit more of a challenging pitch because of who owns it. Traditionally, direct retail has not had a lot to do with A MT and it makes no sense from a policy standpoint that it trades at three times the spread today as it did in 17 pre tax cut and jobs tax, over 5 million individuals paid the A MT and now it's like 110,000, right? It's a blip. A MT spreads are very highly correlated to mutual fund flows, not policy changes. So as Jamie mentioned, mutual fund flows have been okay, they haven't been great. Most of the demand has been coming more from the SMA and ETF side of the equation. So if you have a belief that mutual funds, mutual fund flows are going to increase, a MT spreads are going to drop. So for now being able to buy a MT at 60 70 spread to non A MT bonds when we believe that the future will have mutual fund inflows to us as more of a spread tightening strategy than any policy change.
Alex Chilton (22:19):
I think it's a good point because I think our municipal market is sometimes all about education and it's a great thing that 72% of our market is owned by Americans, that they're funding American infrastructure, that there are 50,000 issuers that there are 800,000 CUSIPs. But sometimes it takes a little bit more time and a little bit of education with people to guide them towards I think sometimes the right decisions in our market. Molly, I'm curious as you're thinking about things, we talked about some of the opportunities here. Are you seeing any worries on the credit side? We have tariffs outstanding, we have news articles and headlines out there, potential cuts to the Medicaid formula. How are you looking at that? How are you looking at the resiliency of our credit portion of our market?
Molly Shellhorn (23:08):
Sure. Well, we're definitely worried about future economic downturn and the impact that that might have on revenues, but we think generally states and local governments and a lot of credits are very well positioned to go into this period of downturn. Fund balances are still strong. We still see revenue, modest revenue growth. We think most issuers will be okay and are prepared if we might see some fund balances be spent down, but there are a lot of uncertainties. And one you mentioned is Medicaid funding.
(23:45):
That
(23:45):
Is one we're thinking a lot about. What would the impact be on state budgets and states are in the process of putting together the budgets right now with a lot of unknowns. They don't really know what the policy, where we're going to end up on Medicaid. And so that makes it really challenging to budget and plus probably forecasting slower revenue growth. So we see definitely state budgets pressured and we could see some rollback. Moody's did a really good study in February that did some stress testing on how state budgets would react to Medicaid funding changes and cuts and made some pretty reasonable assumptions about rolling back the reimbursement rates. And they estimated that the budget gaps would be anywhere from five to 22%. Some of state source revenues, some states can absorb that. Some states don't want to absorb that. Why would you want to absorb that in one year and spend down your fund balance? So we think there'll be changes and then that has a trickle down effect on other issuers. What impact does that have on non-for-profit hospitals? Do they, especially ones that are particularly reliant on Medicaid funding, what impact will there be for higher ed, local government revenue sharing, school district funding, all of the entities that depend on state revenues and state budgets. So we are thinking about a lot of these issues, but it's still well very well positioned in terms of fund balance. And I guess I would just stop there.
Alex Chilton (25:23):
Okay. Any other thoughts on the credit topics on the panel?
John Murphy (25:27):
Can I just say one thing? From a credit side, you're always facing some type of credit crisis. There's always something looming. If you're an issuer and I think Rob Daley hit on it yesterday, tell your story, make it as easy for investors to find out what your story is. You get to control the narrative, put the information out there. So Naveen, BlackRock, everybody else out there can make the decision and if they have questions they'll call you. But if you take that out of the game, you only have to deal with the market when you're issuing debt and for that standpoint and you have analysts that understand your credit, you're in a better credibility spot. I think it works that all you have to worry about is if they're going to show up when your deal comes. And I'd ask them, when do you show up for deals and what is the best issue or what is the best situation for when you're buying bonds?
Molly Shellhorn (26:14):
I mean, when we have good disclosure and a good credit story and an issuer that can tell their story and lay out this is our plan, this is what we expect here, our projections, I mean a lot of times we're looking at a lot of deals on a weekly basis and you don't always have the opportunity to talk directly to the issuer. It's helpful when forward looking projections are in the official statements and in the rating agency reports to the extent that you can be as transparent as possible about your budget, that is very helpful. Budgets should be posted on issuers websites and easy to find with budget narratives included. That isn't always the case. So I would say telling your story as clearly and often as possible is very helpful.
Sean Carney (27:03):
I would agree with Molly and just Ed that we're long-term investors when we invest in your credit, we're looking to partner for many years. So having access and transparency, not only at the time of the transaction but ongoing is incredibly important for us.
Jamie Doffermyre (27:19):
I would say from my standpoint, what I've always loved is the investor issuer connection. And I think sometimes our issuer clients are worried about giving investors too much information. And to me it's like those relationships matter a great deal. And the beauty of our market is we have investors that care deeply about your infrastructure, your school systems, and they want to be helpful. And I think more often than not, if you guys have the information at hand, you can make a decision and recommend either on a spread basis or a credit purchase basis on just about any credit. And I feel like, I mean that's something that we try to strive to tell our clients that let's make sure we understand our investors are partners and I feel like they truly are.
Alex Chilton (28:11):
So I want to move a little bit here to the trend in ETFs. Sean, I know that your firm is a big proponent and has been doing a lot of work in this space. Talk to me about index eligibility. Talk to me about what that means to an ETF and as you think, and you're speaking to the issuer community, what does index eligibility mean? Does it change the price on the bonds? Is it something that an issuer should control, can control? Is it something to be thinking about these days? Because I know that the flows into ETFs, maybe talk about this a little bit, have been increasing. I think that the market prominence of moves in the past three days, how they were driven a lot by changes in ETF flows is something to note. What are your thoughts on this space?
Sean Carney (28:59):
I think it's a good topic to discuss. I mean, the index eligibility creates somewhat of a bifurcation in the market, right? Either you're a larger issuer where ETFs are going to step in. Earlier I mentioned just understanding who the end user of your product is. I mean, we can talk about passive ETFs, active ETFs, or just together. The amount of demand that they've had is sensational. I think it does create a decent amount of buying of similar credits, similar bonds, so maybe a bit of less diversification when we're talking specifically about ETF purchases. But the ability to be able to have your index eligibility, you're going to have a lot of liquidity around those. You're going to have a large audience, the non index eligible, depending on what the market feels like, if we're seeing massive inflows, there won't be that much of a spread between index and non index that'll get made up along the way.
(30:00):
However, when you're not seeing great inflows, traditionally, you will see somewhat, we see it in the taxable world similar. But I think that this shift towards more liquid, more transparent instruments such as ETFs. In the last year, all we've heard about are active ETFs. They're easier to get into models. Financial advisors like them, they're great for investors because fees are significantly lower than what you would've had in a traditional mutual fund. But yeah, your buyer base is there. The demand is greater for larger size and index eligibility, but at the same time, those that are looking for diversification, look for the non index eligible that may have somewhat of a spread associated with it.
Alex Chilton (30:42):
So Jamie, what are you seeing in the spread in the market right now between index and non index in the tax exempt space and what do you think it's going to be in two years looking at the market trends?
Jamie Doffermyre (30:49):
Well, I think the someone's point, it all depends on the market, but I would think for this audience you have to really understand where your buyer base is. Where's the most liquidity in the market? So in a given week like this, the spread could be substantial.
Alex Chilton (31:06):
What does substantial mean? Put some guardrails around this here. Okay,
Jamie Doffermyre (31:10):
Well I can share a recent experience. We price priced the recent transaction, the deal size was 30 million. And if you think about our average deal size in market's, probably roughly 40 or 50 million. So pretty in line with the consistency of it, but there's a couple of things in that transaction stood out. The one rating deal came with one rating. And let me be very clear, we can price transaction with one rating. It's not a problem. But you do limit your buyer base because in different prospectus you guys have to operate with two ratings, not in all your funds but some funds. So all of a sudden you limit your buyer base if you're coming to market with one rating. Then the fact that it was not indexed, we had a pretty standard appropriated credit where we didn't quite see the subscription we thought. So we ended up having to take down a significant portion of the deal and we were probably in that case, 15 to 20 base points water than if it was an index type security and we had two ratings. And so I think that's probably on the extreme. I think in the day-to-day nuance of mutual funds of buying versus ETFs buying is probably, if you're a mutual fund, you're probably saying, okay, if it's index, I'll probably pay two to three basis points. But I think in two years or three years time, that's five 10 probably more akin to what we've seen in the taxable market.
Alex Chilton (32:21):
So Sean, what percent of the market right now is ETFs and where do you think it's going to be in two years, five years?
Sean Carney (32:28):
The ETF growth from where it was 10 years ago to now is exceptional. I don't think it continue at the same pace, but just like we watched foreign investment expand in our market since 2009, 2010 and kind of plateau, I think we'll see ETFs for the next four or five years continue to gap up before finding somewhat of a plateau. I could certainly see ETFs overtaking the mutual fund space in the next couple of years. It's just, it's where investor demand is. And to Jamie's point, just real quick to close the loop on index versus non index, it also matters how you're obtaining those bonds, whether you're obtaining them in the primary market or in the secondary. I noticed a bit of a larger spread in the secondary when just bidding on bid lists compared to maybe where they come in the primary as well. So that matters.
Alex Chilton (33:19):
So I think ETFs have climbed the past five years from one or 2% to about 4% in the market mutual funds. Jamie, you're talking about having declined from 26 ish to twenties. So I don't know, maybe in the next couple years we start to see ETFs climb close to 10 mutual funds move in the other direction. So John, I want to throw one over to you, right? You're the head of PFMs investor relations advisory services. Let's say you're sitting in a room filled with retail investors, you got a room of 300 retail investors. What do you want them to understand that you don't think they understand?
John Murphy (34:00):
Well, from a retail standpoint, I don't think retail understands as much as they need to. And I think that's where the drive for separately managed accounts and being in ETFs and being in other kind of products that other than individual bonds. But if you're talking about the availability of information of what they should be looking for, where they should be looking for that information and how to use that information. And that's why we talk to our clients about getting as much of that information out and easily to read and access is the important part of it to make the retail investor more comfortable with their purchasing. The MSRB does the tracking of the trades. Emma is, it's a mess, but it's getting better. There are not many good tools out there finding information quickly and easily. That's mandatorily required. But S in a beta testing or MS rrb is doing a beta testing of their new Emma, which is going to be substantially improved.
(34:51):
So that should help just making sure you're looking in all the right spots for that information. And maybe it's local stories, maybe it's news and things like that that are going to affect the credit, but affect the your overall thought of the credit. But making sure that that information is available I think is the most important part. And on the SMA side, or maybe not so much on the ETF side, but reaching and on the mutual fund side, reaching out and having that dialogue with the BlackRocks and naves, whoever else in the community is making sure that that's a good thing. That's the credibility build that you need from an issuer standpoint to win. So looking at retail investors, if there's that credibility, you're telling your story the correct way, you're out there in the market, information's easily available so they can access it, and I think that'll make for a more orderly kind of municipal market.
Alex Chilton (35:46):
And how about from the dealer community? Any asks there? What's that? And how about from the dealer community? Any asks from the dealer community?
John Murphy (35:54):
Yeah, more liquidity? No, the dealer community from the underwriting side, when we talk and we're bringing deals, there's a process and understanding where things are trading in the market. Our pricing group is walking with the pricing groups on every desk out there for deals we're bringing to make sure that we are setting the parameters for where we think our client should be pricing in the marketplace. And to be as honest and open with your client that you're bringing the deal for is to make sure that you're within that range. Everybody has the expectations set and dealers appreciate that. The deal from the deal side, I look at it, you're the one selling our bonds, so you're out there interfacing with the client, you're telling our story on our behalf. So we want that story to be as clear as possible. And I know I'm beating this point to death, but if we tell the story and if our client tells the story efficiently to the underwriter, to the sales manager, to the salesperson, to the buyer, it's a little telephone in there, but we want to make sure that story's as clear as possible to tell that.
Alex Chilton (37:04):
Okay. I mean, as a member of the dealer community, I think Jamie and I can say that we're working on it, that the liquidity matters to us as well. And look, I think the biggest challenge that we've been facing are the more dramatic moves in the muni market. When you see during covid munis move a hundred plus basis points in a week where you see during tariff tumble markets move 90 basis points and you just do the math in terms of what that costs, I think that that becomes more and more difficult. And I think when people talk about liquidity and they talk about the gap, Jamie, you were talking about in the market about where banks and insurance companies will come in just because tax rates are so different. I think it's important to connect those two concepts. And I think that the reason why there are more gaps in the market is that there's been a fundamental change in that the marginal buyer now is always retail, but the reason why dealers are also it costs them so much to provide liquidity is because the drawdowns are bigger.
(38:05):
And I'm curious, I'm curious to ask this panel if we just think it's a negative feedback loop and it's going to get worse and worse, or if you see any green shoots where that cycle might reverse because I think over the past five years, the moves have become more dramatic, right? Sean? I think you were talking about balances that dealers hold have declined, and as much as we commit to the market, it's more becoming more and more expensive and we are here and we are here to do it. But I'm curious if you think that there's going to be a market dynamic that might potentially reverse that
Sean Carney (38:39):
As long as the gap between where the renters of the market, your crossover buyers tax rate is 21% in the marginal retail is 37, 38, 39. As long as that gap is created, you're going to have larger swings in sell offs. I mean, we have been in an environment where ratios are beyond explainable for a long period of time, but we all knew in one way, shape or form when the market backed up, you are not going to attract that marginal buyer for many, many basis points. So I think as long as that remains, you're going to have larger swings. I will say however, that, let's take the covid period volatility out and let's take these last five trading sessions out because they're abnormal in nature. But Jamie had mentioned at times at being at shops that had 3 billion on balance and being at a shop with 1 billion, we have watched several shops that have a billion on their balance sheet make it look like two and three because of the flow trading that they can do with it, creating more liquidity with inside the market. And I think that's kind of what we need more of. It always feels incredibly easy to buy bonds. It's not equally as easy to sell bonds in volatile times, so just more flow. But yes, I think we're in a market where, and as long as that gap in where the traditional owner of the market and the non-traditional renter of the market is spread, we're going to have more illiquidity challenges. Well,
Alex Chilton (40:05):
I'm going to ask the question algos. Are they providing more liquidity or less liquidity? Are they good for liquidity of the market? Do you, do you not like 'em?
Jamie Doffermyre (40:15):
Me,
Alex Chilton (40:16):
Anyone on the panel here?
Jamie Doffermyre (40:17):
I would say a couple thoughts. I think algos are great for the market, honestly, I do because you think about how you can take your intellectual knowledge and then scale it and then serve separate managed accounts who ultimately in a market like this, provide the bulk of liquidity. Just be very, I think, clear. If you think about where you're going to find liquidity from an investor base, it's definitely, in my opinion, in a separate managed account or the consistency of that liquidity, and that's inside 15 years and a lot of the algos provide that. I think the nuance when we think about alternative pools of capital is a different story. Because even though dealers, I would say, if you think about the dealer community, and we're, unfortunately, we were hoping to get five years past the covid, so our variance calculations will be a little bit different and now we've got to wait another 10 years past this week. But ultimately, if you think about there's all these alternative,
Alex Chilton (41:13):
So sorry, Jamie, just a little bit of context to that point versus what we are talking about banks and dealers manage risk losses the most recent past five or 10 year crisis. So the reason why it's become more difficult, I think Jamie, is what you're saying is that the next time risk managers look back at a dealer and say, how many bonds can you own? They're going to say, well, if you owned 500 million bonds or a billion bonds or a billion and a half bonds, how much would you have lost during the tariff crisis or the
Jamie Doffermyre (41:41):
Yeah, exactly. So now we have a new benchmark.
Alex Chilton (41:43):
Now we have an new benchmark, all right,
Jamie Doffermyre (41:44):
But hopefully six, seven years now
Alex Chilton (41:46):
Monday through Wednesday we
Jamie Doffermyre (41:46):
Look past. But I feel like the other interesting about, so what has transpired, because as deal community, I think as we have gone from 50 billion to six to 10 billion, there's definitely alternative pools of capital, whether hedge funds or sleeves of hedge funds that do provide an extension of balance sheet, but they're typically one way directional. I feel like that balance sheet's more predatory. So at times it feels like the market has more liquidity than it has. And then this week when everyone's like, oh, okay, I can't participate because what I own is going down 20 base points a day,
(42:20):
It feels like there's no liquidity. And then yesterday afternoon you can't buy a bond and then today you can't buy a bond. It's like there's this definitely, I think the Green Street is the market is operating. Let's be very clear, the market did trade this week. We traded a lot of bonds on any given day, and if we compare ourselves to ig, the IG wasn't pricing new issue this week. So I mean, I feel like we are functioning, but the swings and the volatility has everything to do with the differential and tax rate that we talked about too.
Alex Chilton (42:53):
So I did run the numbers on the positive side as well. Today is going to be the fifth largest rally in the municipal market since 1981. Largest was in 82, followed by covid, followed by covid, again, followed by 82. And this is going to be number five.
Sean Carney (43:10):
And if you look at it from a price standpoint, so when we got cut on what Monday by 40 45 basis points on MMD, the muni main index went down 2 85. Muni main index has never gone down 2 85 in its history. So the pricing moves to then go on top of what happens with MMD are incredible. I mean, I'm not on the desk right now, but I would assume you could have one of the most up days that is ever printed on the Muni main today in its reversal. It doesn't help. It just adds to the volatility of the market. But as we kind of come back here, that's why I think Monday is so important, getting back and resetting on Monday and figuring out what issues are going to come back to the market off the day-to-day calendar and what it's going to look like for the next two, three weeks. What's going to put investors back in their seat and want to buy bonds as long as the undertone feels okay and demand comes back.
Alex Chilton (43:56):
So we're going to prepare you all with a closing question, which is I'm curious for you all to give your odds that something changes in muni tax policy this year, right? So we're going to go down the line just a quick percentage chance from all of you, but before we do that, Lynn asked me to hold five or six minutes here at the end for questions so I can keep talking. I'm sure that we could do this for a couple hours just because we talked munis day and night.
Jamie Doffermyre (44:20):
Oh yeah, love it.
Alex Chilton (44:21):
But wanted to open up, see if anyone had any topics, any questions they wanted answered, anything they want us to mull over in the last five minutes. I take that as a really good sign that we've covered. All right, here we go. In the back
Speaker 8 (44:39):
Exit housing, my name's Jason Riff, launched a company. We're doing about 2 billion of pipeline right now. We're looking at underwriting. What are your thoughts on bonding for affordable housing construction or preservation?
Alex Chilton (44:55):
It's a great question. Look, one of the things that I have my fingers crossed for is that affordable housing seems to be one of the most staunch bipartisan topics that I have ever heard people talk about. Now, on the other side, most of those bonds are also private activity bonds. So I hope that the generous lawmakers that will decide our fate here, keep that in mind and do the research and don't necessarily lump a category of something is that is working incredibly well into other categories and that they see that all of these bonds are really helping the market in many ways. But let's take the question in the panel demand for affordable housing bonds, what have you seeing?
Jamie Doffermyre (45:43):
I think they're all for extraordinary value, right? I think that's one of the sectors I didn't mention is that opportunity. I think what we're seeing in affordable housing sector and the who's coming to market, I think it's a great opportunity for investors. Typically, the credit quality versus the yield pickup I think is substantial.
Alex Chilton (46:03):
So I think what I would encourage issuers to think about is that we've seen a number of different affordable housing bond structures that have performed incredibly well in the past six months. If you take a look at the Freddie insured bonds, those spreads have tightened down materially. If you take a look at the securitizations that Citi has done of 4% Litech properties, those have also tightened about 50 basis points, like this is all pre Monday. And I would say that the market has had general better receptivity to pools of projects done together because I think that there is a very strong belief, and it was tested during 2008 that affordable housing projects withstand market rent moves better than market rate properties. And especially if you take projects from multiple regions and you pull them together, the strength of that combined pool is well in excess of any individual project.
(46:59):
So if there is the ability to take multiple projects and put it together, I think we've seen incredibly strong demand patterns from the market. And I think that the market is starting to accept the projects more and more. So it's something that we've talked about at our structured finance conference, just the education needed to the muni market that when people say structured, when people say complicated, the thing that I think the muni market needs to do is to talk about it. And I think affordable housing is something that our market needs to talk about more. And the more that our market can talk about it, the more that people are going to understand it and the more that people understand it, they're going to see the credit quality and those credit spreads are going to come in the more the dealers are going to trade it, and the more the mutual funds will potentially accept it and maybe makes its way into indices as well, which would be helpful. Any other questions out there? David mentioned you got a microphone coming on your right,
Speaker 7 (47:57):
Sean, you mentioned index eligibility for ETFs. So besides ratings, what makes a bond index eligible in the tax exempt market
Sean Carney (48:07):
Size specifically? So size of given maturity, I want to say maturity is 200 million index eligible size of a maturity and then of the overall deal. So dealing with larger, more common issuers. But hence the reason I mentioned that. I think that it kind of creates a bit of a lack of diversity when you have issuers this way, everybody across the board is getting involved. So in something like MUB, which owns about 60% of the overall market, a lot of that concentration is going to be in obviously the most highly eligible names.
Alex Chilton (48:49):
I think we got time. Yes. One more question. Go ahead.
Speaker 9 (48:52):
Hi. Thank you. Thanks for your comments. Super interesting panel. Curious you, I mean obviously you guys probably all cover or talk to your colleagues in other asset classes. What are you thinking, and maybe this is more for Sean and Molly, but the public versus private market dynamic and how that, I mean, I would argue that Munis have always had a private market and that this nuance of private market development is really more around the projects maybe and the difficulty and the structures. But how are you seeing maybe any private market activity coming in to potentially solve this liquidity issue?
Sean Carney (49:32):
I can start and hand it to Molly. I think the adoption of new instruments into our market, such as interval funds and LPs and things like that are lending themselves to be able to get involved in more private activity. Mainly because of the lockup period. It's very difficult for us to lend money and do some of the deals that we'd like to knowing that we can have daily liquidity needs. So for instance, in an interval fund where we have a three month lockup period and we have what we consider to be more sticky capital we can get involved in, I agree with you that it's always kind of been a part of the market. I think now it's just kind of being a little bit more of a carved out part of the market where these new instruments are allowing more players to get involved. And again, where there's demand, you'll create supply. So I think that the supply side will increase.
Alex Chilton (50:23):
Look, the biggest positive that I see about the private markets, and it's something that we participate in as well, is that it can offer certainty to an issuer. The public market process takes time to get documents together, markets move quickly. The private market process, you're usually negotiating with one or two investors. And the positive to it is that those negotiations are quicker and more certain. So the best way to hedge a project and the best way to hedge munis is to sell bonds. Now we all know where forwards price. We all know how difficult it is to hedge munis. The best way to hedge munis is to issue bonds when you can issue bonds and to do your project when the project works. And I think that the private markets are really nice to have as an option for the muni market because sometimes people need to come to market fast, sometimes need certainty of execution, and sometimes it's easier to deal with one party than to deal with a syndicated process where there's going to be 30 one-on-ones in an order book of 40 or 50 different clients. So I think we're over time here just to end it up. Percentage chance of some type of tax policy change just a number and run it down the line.
Jamie Doffermyre (51:26):
Yeah, I would say zero, and I'll throw this out. So between 1930 and 1935, we can understand the dynamics of that economic cycle. The intergovernment tax immunity was challenged or tend to be challenged 80 times and with zero success.
Sean Carney (51:42):
I like that answer, Sean. Mine's going to be slightly higher. I'll go one in five. So 20% chance we don't believe the tax exemption itself is on the table. But in a shared sacrifice scenario, could there be a cap put on high earners or a carve out of certain targeted private activity bonds? It's possible. This administration is already proven though. They'll do things that are very difficult to handicap. Molly,
Molly Shellhorn (52:03):
It's not zero. We definitely think there is a threat to private activity, bonds, some erosion on the tax exemption. For some subset of private activity bonds is likely.
John Murphy (52:15):
John, this is my opinion, not PFMs opinion. I'm at 10% and Murphy is an optimist by all the time, but there will probably be some changes that'll be tweaking it around the edge. But I don't think overall the whole tax I exempt goes away.
Jamie Doffermyre (52:31):
Gas prepay goes away.
Alex Chilton (52:32):
Gas
Jamie Doffermyre (52:32):
Prepay. That's the only exception that would gas
Alex Chilton (52:34):
Prepay and
Jamie Doffermyre (52:35):
Energy prepay goes away
Alex Chilton (52:36):
Stadiums. All right. Well, very much appreciate everyone's time. If there are more questions we're going to be around, please come up and ask.