Demand for high-yield debt and a desire to diversify away from tobacco bonds have sent prices for American Dream into the stratosphere, buysiders said.
A USD 500m 7% Series 2017 tranche of tax-exempt bonds due 2050 traded at 117 on 15 September in round lots to yield 4.8%, according to Electronic Municipal Market Access (EMMA). The Wisconsin Public Finance Authority issued the unrated bonds at 102.7 to yield 6.6% in June as part of a larger USD 1.1bn package that took months to get off the ground.
Solid demand for high-yield debt and the deal’s initial pricing on the cheap side have propelled prices, according to Steve Czepiel, a senior portfolio manager at Macquarie Investment Management, which oversees about USD 8.5bn in municipal bonds.
“You don’t have a lot of paper in the market that is coming at a 6 5/8s-type-yield,” Czepiel said.
New kid on the block
Two trends have kindled the rally. New federal regulations of tobacco products announced this summer could impact cash flow funneled to tobacco bondholders, a hairy instrument with lots of liquidity in an otherwise dormant market.
The second factor is the confluence of macro-factors: Tight spreads and continued cash flows into high-yield, open-end mutual funds, said Robert Amodeo, head of municipals at Western Asset Management Company, a Legg Mason investment affiliate.
The US Food and Drug Administration’s (FDA) 28 July announcement that it would pursue cutting nicotine in cigarettes to non-addictive levels likely benefitted American Dream bonds, Czepiel said. The news weighed on tobacco bond prices, the portfolio manager said.
A USD 1.3bn 5.875% Series 2007A-2 tranche of Buckeye Tobacco Settlement Financing Authority bonds due 2047 traded in round lots on 13 September at 97.3 to yield 6%, according to EMMA. The bonds have strengthened since early August when they traded in round lots 91 to yield 6.4%.
“Maybe [investors] were holding onto their tobacco securities, but putting any new money into things like American Dream,” Czepiel said. “I think those are some of the reasons why we’ve seen [American Dream] do so well.”
The marketplace is well aware that demand for combustible cigarettes continues to decline, Amodeo said. If other states hike excise taxes as California did, demand could fall further. While strong, the FDA announcement will take time to translate from rhetoric to regulatory movement, he said.
While American Dream bonds may have benefitted at tobacco bonds’ expense, Amodeo said any impact was likely “at the margins.”
A rising tide
When it comes to attractiveness, American Dream checks off a lot of boxes for buysiders faced with putting cash to work, said Amodeo.
New municipal bond issuance has totaled USD 257.9bn in 2017 through August, according to the Securities Industry and Financial Markets Association (SIFMA). That’s down about 14% from USD 301.1bn during the same period in 2016.
At the same time, nearly USD 20bn flowed into municipal bond mutual funds and exchange-traded funds in 2017 through July, according to the Investment Company Institute (ICI). That compares to net inflows of more than USD 43 billion for these funds for the first seven months of 2016, ICI said.
Fund flows would need to reverse in order for the rally to lose steam, said Czepiel. Another variable that could weaken American Dream prices is, from a relative value assessment, another large deal that someone would sell a portion of their bonds to buy, he said, adding that big high-yield deals like American Dream are rare.
“The technical environment of demand for yield has remained very, very strong, and, as a result, American Dream bonds represented an opportunity to diversify a pool of risk for portfolio managers,” said Tom Casey, a senior portfolio manager at Standish Mellon Asset Management, a BNY Mellon investment boutique.
Despite their recent weakness and rebound, tobacco bonds have enjoyed a spectacular run, said Casey.