Bottom Line - CDFA

September 23, 2013 | Fixed Income Strategy

Municipal Bond Market Weekly

Bottom Line:

? Treasuries and municipal stage big rally on surprise delayed taper and dovish implicit guidance ? Muni fund flows negative but less than previous week. High-yield funds saw net inflows. ? Moody's issues comments on state and local government pensions ? State oversight a good thing for local governments but doesn't not necessarily preclude local

government and school districts from eventual default/bankruptcy ? Puerto Rico releases 2012 Comprehensive Financial Report ? deficit grew but government

confident in changes

What Happened in the Muni Bond Market Last Week?

Thanks to a highly unexpected non-taper by the FOMC and updated guidance (with economic forecasts and projected Fed Funds rates), fixed income markets staged a big rally last week. The bottom line at the conclusion of the Fed meeting was that they were more dovish which caused yields to contract across all fixed income markets (see the Treasury yield changes below). The thrust of the rally occurred on Wednesday and then mostly held serve for the rest of the week. The magnitude of the initial move, while not epic, was quite impressive indeed. The municipal market took a few days to price the move in but ultimately found its footing and matched the move by the end of the week. There was significant commentary from traders (read in Bond Buyer) that indicated some underlying strength to the market's readjusted attitude, even defying some Treasury market weakness on Thursday. In fact, the municipal market had seen, through Friday, eight consecutive sessions of gains.

? For one week (ending 9/20/13) Treasury 2-year Notes were lower by -10.1 bps to 0.33%, 5-year Notes were 21.6 bps lower to 1.477%, 10-year Notes yields fell by -15.1 bps to 2.734% and 30-year bonds were -7.4 bps lower to 3.761%.

? Municipal bond yields (for the same period) also finished with lower yields - AAA-rated GO yields; 2-year bonds were -3 bps higher at 0.43%, 5-year bonds were -14 bps lower at 1.47%, 10-year bond yields were -20 bps lower to 3.00% and 30-year bonds were lower by -15 bps at 4.32%.

? The Ratio of 10-year AAA GO debt to 10-year Treasury was 104.6 nearly unchanged for the week but is down from the 110-11 range approximately a month ago. The average ratio for 2013 is 103.4 and the average ratio for the past 12 months is 103.3.

Municipal Bond and Treasury Yields (Figure 1)

One can observe these changes by looking at how rates have changed along the curve for both the Treasury curve and for the AAA-rated G.O. Index since last week. The top panel of graph on the following page shows four yield curves; two for the Treasury curve (in red) - one for the most current date and one from last week and two for the AAA-rated G.O. (in blue) - current and last week. The bottom panel of the graph shows changes in the rates along both curves for the week for both Treasuries and the AAA G.O. Index.

David N. Violette, CFA

B. Craig Elder

Ronald Freisleben, CPA

Fixed Income Analyst

Senior Vice President

First Vice President

Vice President

celder@

rfreisleben@

dviolette@ 414-298-7688

414-765-3768

414-298-7637

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September 23, 2013 | Fixed Income

Figure 1 - Yield Curve and Muni Curve Changes ? Data Source: Bloomberg

Ratio (%)

Figure 2 - Muni Ratio ? Data Source: Bloomberg

AAA 10-Year G.O. Muni Ratio to Treasury

125 115 105

95 85 75

Mid Price

SMAVG (50)

104.6

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September 23, 2013 | Fixed Income

Bond Buyer Indexes (Table 1 and Figure 3)

The Bond Buyer Municipal Indexes weekly yields declined last week. The 20-Bond GO Index of 20-year GO yields fell 27 bps to 4.66% - this is the lowest yield since 7/18/13. The Bond Buyer's Revenue Index of 30-year revenue bond yields declined by -7 bps to 5.24%.

Index Bond Buyer 20 Gen'l Obligation Index Bond Buyer 11 Gen'l Obligation Index Bond Buyer 25 Revenue Index

Table 1 - Bond Buyer Indexes ? Source: Bloomberg

Yield % 4.66 4.39 5.24

Yield Last Week 4.93 4.67 5.31

1 Week Change (bps) -27.0 -28.0 -7.0

Yield 1 Month Ago 4.8 4.57 5.18

1 Month Change (bps) -14.0 -18.0 6.0

Figure 3- Bond Buyer Indexes - 1 Year; Data Source: Bloomberg

Bond Buyer Indexes

1 year 5.5

5 4.5

4 3.5

3

Yield (%)

Bond Buyer 25 Revenue

Bond Buyer 20 General Obligation

What Are Market Participants Talking/Writing About?

Supply (Figure 4) ? The lack of supply has aided the market. The Bloomberg 30-Day Visible Supply, at $5.1 billion, is near the lows of the year. An increase in refunding supply and new issue might be expected if yields remain low. This week's light calendar (of $4.01 billion) will be highlighted by two large deals including University of California and New York City.

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September 23, 2013 | Fixed Income

$ Million

20,000 18,000 16,000 14,000 12,000 10,000

8,000 6,000 4,000 2,000

0

Bloomberg 30-Day Visible Supply

U.S. Total

Articles of Interest

Muni Funds Withdrawals Slow ? Outflows from municipal bond funds slowed last week to $1.1 billion last week (from $1.8 billion the previous week) according to Lipper FMI ? the lowest rate since the week of August 7th. High-yield funds bucked the trend and actually saw net inflows for the week.

Moody's Comments on Both Local and State Pension Conditions ?

? State Pensions: Moody's says that pension liabilities are manageable for most U.S. states. However, high pension liabilities relative to revenues is a credit negative for some states as it reduces the state's capacity to cover other expenditure such as other debt service requirements. A common reason for such high liabilities is consistent underfunding. Reforms taken by some states will take years to work through the systems to realize the benefits. Moody's uses a metric, Adjusted Net Pension Liability (ANPL), which is the difference between the fair market value of pension fund assets and its adjusted liabilities (adjusted discount rate applied) to available revenue. The state median ANPL is 45%. The states with the highest ANPL are Illinois (241%), Connecticut (190%) and Kentucky (141%); nine states have ANPLs > 100%. The states with the lowest ANPL are Nebraska (6.8%), Wisconsin (14.4% and Idaho (14.8%). High pension liabilities have been factors, among others, for several downgrades in recent years of some states including those listed above with the highest ANPL and case for negative outlooks including those for Hawaii, New Jersey and Pennsylvania.

? Local Government Pensions: Moody's provided similar commentary on local government pension plans. Comparatively, the average ANPL for over 8,000 local government is over 100% (vs. states' median of 45%); 30 of the top 50 local governments (the ones with the most debt) have ANPL's of >100%. Local governments are more affected by pensions due to the higher labor intensity operations of local governments. Unfortunately, governments have less financial flexibility and ability to control pension problems. Moody's notes several local government for their high ANPLs; Chicago (680%) and Cincinnati (380%) are clear outliers with others noted including Cook County Illinois and Denver County School District. Recently Moody's downgraded 18 of 29 local governments that were put on review in April 2013.

Moody's Says State Oversight of Distressed Local Governments Positive ? Moody's has recently concluded a study of the support powers and track records of each of the 50 state's oversight of financially distressed local governments.

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September 23, 2013 | Fixed Income

They offer several key conclusions: a) Strong oversight is generally a credit positive for those local governments that are financially stressed. b) State oversight and intervention does not necessarily preclude a local government from default or bankruptcy (Detroit as a recent high profile example). c) A state's oversight has not historically detracted from that state's own credit quality because direct bailouts have not occurred. d) The oversight mechanisms, for those that implement them, vary widely. e) School districts have benefitted from strong oversight much more (3:1) than non-school local governments.

Puerto Rico Last Week ? ? Last Monday (9/16), the Government Development Bank (GDB) posted the 2012 Comprehensive Financial Report (for the fiscal year ending 6/30/2012). The audited deficit was $1.337 billion as compared to the 2011 deficit of $1.081 billion. General fund revenues increased by 6.7% but expenses increased by 8.43% - projected expenses for the current year are anticipated to be less. The current government stressed the improvements made since the taking office at the beginning of this year. One can find the press release and the complete 305 page CAFR at gdb-. ? From Bond Buyer ? Several government officials have suggested that Puerto Rico Electric Power Authority (rated `Baa3' by Moody's, `BBB' by S&P and `BBB-` by Fitch), one of Puerto Rico's biggest debtors ($8 billion outstanding) could be restructured ? the options being bandied about are wide ranging including, splitting distribution form power generation to partial privatization. A November recommendation is expected.

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