Boston - Eaton Vance and its affiliates seek to actively capitalize on opportunities presented by volatile investor sentiment, while ensuring that the portfolio risk profile remains appropriate for the specific strategy. The following are excerpts from a recent conversation with Cindy Clemson and Craig Brandon, CFA, Co-Directors of Municipal Investments for Eaton Vance Management.
What we are seeing: After an extremely volatile month, the municipal market as represented by the Bloomberg Barclays Municipal Bond Index finished down 3.63% in March. So far in April, yields have moved lower, with the 10-year muni yield declining 26 basis points and the 10-year US Treasury yield down 8 basis points through April 14.
The Federal Reserve announced the authorization of a Municipal Liquidity Facility on April 9, which will support lending to states, cities and counties. In short, the Fed has established a Special Purpose Vehicle (SPV), which will be allowed to purchase up to $500 billion of short-term notes with maturities less than 24 months directly from issuers at the time of issuance.
What we are doing: The biggest news of the week was the introduction of the Fed's Municipal Liquidity Facility, which was well received by the market as it addresses a key investor concern: Are states and cities going to run out of money and default on their debt? This program puts in place a mechanism that enables municipal issuers to bridge the revenue gap they are facing. That is very important in our market since liquidity is driven by retail investors who tend to sell municipal holdings when they are fearful. The municipal market has experienced over $35 billion in outflows since March 5; hopefully, this new facility should give retail investors confidence to hold and potentially add to their current municipal investments.
We will be focused on fund flow data over the next week, and we believe a key near-term data point to gauge the effect of the Municipal Liquidity Facility will be whether fund flows rebound from negative to positive. Beyond that, from a trading perspective, the immediate impact of the Fed's new program can already be seen this week as some of the most volatile issuers over the past four weeks are trading significantly better and outperforming the broader market. The immediate impact of the Fed's new program can already be seen this week, with successful new issue deals from a prominent private university and a large state's general obligation debt appearing to be a step in the right direction.
What we are watching: We are closely watching the roll-out of the Fed's SPV and how the market reacts to the unprecedented step to support municipalities. The SPV will purchase short-term notes from states, cities (with populations over 1 million residents) and counties (with populations over 2 million residents). Here's an overview of some of these details:
- Eligible notes include tax anticipation notes (TANs), tax and revenue anticipation notes (TRANs), bond anticipation notes (BANs), and other similar short-term notes issued by eligible issuers, provided that such notes mature no later than 24 months from the date of issuance.
- Eligible issuers can be a state, city or county, subject to review and approval by the Fed. Only one issuer per state, city or county is eligible.
- Limit per state, city and county. The SPV may purchase eligible notes issued by or on behalf of a state, city or county in one or more issuances up to an aggregate amount of 20% of the general revenue from own sources and utility revenue of the applicable state, city or county government for fiscal year 2017.
- Pricing will be based on an eligible issuer's rating at the time of purchase, with details to be provided later.
- Origination Fee. Each eligible issuer that participates in the facility must pay an origination fee equal to 10 basis points of the principal amount of the eligible issuer's notes purchased by the SPV. The origination fee may be paid from the proceeds of the issuance.
- Termination Date. The SPV will cease purchasing eligible notes on September 30, 2020, unless the Federal Reserve Board and the Treasury Department extend the facility. The Reserve Bank will continue to fund the SPV after that date until the SPV's underlying assets mature or are sold.
Final word: We expect a calmer market, at least in the near term, as the Fed has been very proactive in terms of policy initiatives. The SPV could be a dramatic boost to overall muni liquidity and serve as another backdrop to the muni market, which has now seen seven days in a row of positive performance through April 14. Muni to Treasury yield ratios have moved substantially lower over the last week, but we are still on the lookout for opportunities to deploy cash into the market.