Market Commentary: On the Verge

At a meeting of the G-20 nations in Brisbane, Australia in November of 2014, Jim Yong Kim, President of the International Bank for Reconstruction and Development (World Bank), proposed a new way to help developing countries finance efforts against infectious diseases in the early stages of a global contagion. Three years later, as Ebola continued to ravage West Africa in a pandemic that killed more than 11,000 people and set back development there for more than a decade, the Bank looked to transfer some of the effective insurance risk to the financial markets by privately placing $329 million of Floating Rate Catastrophe-Linked Capital at Risk Notes. These were quickly dubbed “pandemic bonds”. Roughly modeled on catastrophe bonds from the mid-1990s that pay out in response to insurance claims for events like hurricanes and earthquakes, the principal would be transferred to the Bank’s Pandemic Emergency Financing Facility (PEF) to aid eligible developing countries with containment and relief efforts after a very specific series of events occurs. The 386-page prospectus outlines the order and magnitude of triggers: when an outbreak reaches a predetermined level of contagion, involves a specific number of deaths, spreads at certain speeds, and crosses international borders producing more than 20 deaths in any additional country. Determinations are made by a verification agent based on publicly available data as reported by the World Health Organization, and the maximum payout in this case is $196 million.

The 2017 Notes were issued in two classes: a $225 million tranche covering flu and coronavirus that was priced at LIBOR plus 6.50%, and a $95 million series covering Ebola and various fevers as well as coronavirus that priced at LIBOR plus 11.10%. Swiss Re Capital Markets, Munich Re, and GC Securities managed the sale, which was oversubscribed by 200%. Interest on the Notes totals about $36 million a year which, along with fees, are paid by donor countries including Japan, Germany, and the soft loan arm of the Bank. No payouts to the PEF have yet been made and due to the number and timing of triggers, it is unclear that any monies would be paid or that they would even arrive in time and sufficient quantity to be helpful. Although there remains considerable doubt about the official numbers, China reached the first threshold for fatalities weeks ago. But due to unsurpassed global efforts at containment, including the effective quarantine of half of China’s population — a staggering number that is twice the size of the United States — no other nation is close to reaching the next trigger point. The 2017 Notes are scheduled to mature on July 15 of this year and principal will be repaid to holders if no recognized event occurs. At this writing, the COVID-19 disease, now officially caused by the virus SARS CoV-2, is not a global pandemic, although officials at the National Institutes of Health believe that the outbreak is on the verge of becoming one. There are now 15 confirmed cases in the U.S and diagnosed infections in 23 other countries. The Notes are said to be trading at a discount now, reflecting market belief that the first payout may well be forthcoming in the next five months.

This year’s G-20 summit will be held in Riyadh in late November and the theme is “Realizing Opportunities of the 21st Century for All.” It is one of a number of international events planned for 2020, including the Summer Olympics in Tokyo, the G-7 at Camp David, the World Expo in Dubai, and the 75th Session of the United Nations General Assembly, any or all of which could be disrupted as a result of the spread of the deadly virus. Traders are alternatively spooked and soothed by the intraday news reports which dominate all headlines. As fourth quarter corporate earnings are released, the term “coronavirus” has been cited in 138 of 364 companies holding calls, and FactSet reports that 25% have referenced some type of impact or modified guidance. The progress of the disease cannot be known, so speculation is rife on the potential economic impact of the coronavirus on tourism, retail sales, production and demand for products ranging from pharmaceuticals to oil to baby carriages and semiconductors. Futures trading now reflects expectations for one or more rate cuts this year, with the first coming in July.

Through the first half of February, stocks fought to keep the rally going in spite of widespread virus concerns. As of the close on Friday, the Dow gained 4% or 1,142 points on the month to close at 29,398. The S&P has risen 154 points to 3,380, the Nasdaq increased by 580 points to 9,731 and the Russell 2000 added 73 points or 4.6%. Oil is up 1% to $52.05, while gold has lost $5.10 an ounce to $1,584. On the fixed income side, U.S. high yield corporates, with more than $50 billion of refinancings so far this year, and preferreds are the only sectors with positive returns on the month. Short Treasury yields have jumped 11 basis points to 1.42%, and 10-year yields have inched up 8 basis points to 1.58%. While 30-year yields have gained 4 basis points so far in February, last week’s government auction fetched a record low yield of 2.06%. The calendar of municipal issues hit a high for the year last week at $9.6 billion and yields this month are up imperceptibly across the curve. The 2-year AAA general obligation bond yield ended mid-month at 0.86%, the 10-year at 1.18% and the 30-year benchmark at 1.82%. Municipal bond funds have taken in $3.7 billion during the last two weeks, sending the inflow streak to a record high of 58 weeks.

HJ Sims was in the market last week with $28.3 million of BB+ rated New Hope Cultural Education Facilities Finance Corporation bonds for Morningside Ministries. The offering met with a strong reception and we sold the 2055 term bonds with a 5% coupon priced to yield 3.35%. Among other deals on the high yield slate, the Public Finance Authority of Wisconsin sold $21.5 million of non-rated senior living facility revenue bonds for Montage Living due in 2024 priced at 8.00% to yield 9.121%. In the education sector, the Arizona Industrial Development Authority issued $42.3 million of BB rated revenue bond for the Cadence campus of Pinecrest Academy of Nevada structured with a 2050 term maturity priced at 4.00% to yield 3.23%; the California School Finance Authority brought a $21.3 million BB+ rated financing for Fenton Charter Public Schools featuring a final maturity in 2040 priced with a coupon of 4.00% to yield 2.07%; and the Public Finance Authority issued $11.3 million of non-rate revenue bonds for 21st Century Public Academy that included 30-year term bonds priced at 5.00% to yield 4.21%. The Berks County Municipal Authority of Pennsylvania had a $19.5 million BB+ rated sale for Alvernia University that had a 30-year term bond priced at 5.00% to yield 3.59%.

This week, we will see more fourth quarter corporate earnings, the minutes from the January Federal Open Market Committee meeting, and economic data on housing, producer prices, and manufacturing. Qualifying Democratic presidential candidates will meet on the debate stage Wednesday night in Las Vegas. The $6.8 billion municipal slate includes a $90.2 million non-rated Pennsylvania Economic Development Financing Authority senior living revenue bond transaction for Quality Senior Housing and QSH/Pennsylvania, LLC, and a $36.2 million BB+ rated Lancaster County Hospital Authority issue for Saint Anne’s Retirement Community. Life plan communities will be the focus of the two-day HJ Sims Late Winter Conference next week in San Diego. We look forward seeing so many of you at our 17th annual event. For those unable to attend this year, we will be sure to share our highlights in the weeks to come.