by Gayl Mileszko
One of the most popular players for the minor league Atlanta Crackers in the 1950s was an outfielder named Bob Montag. The World War II Bronze Star and Purple Heart recipient was wildly cheered for his many majestic blasts over the right field fence, 450 feet from the plate at Ponce de Leon Park, a concrete and steel stadium constructed around a magnolia tree that became part of center field. He hit 113 home runs over his career including one in 1954 that went so far out of the park that it landed in the coal car of a passing train headed to Nashville. The conductor of the train came back to the park on the return trip and asked Montag to autograph the ball. The longest home run in baseball history was thus said to have traveled 518 miles and 450 feet.
Guinness maintains a book of records but many types of measurements, statistics and tales, and are kept, published and passed along in official formats as well as popular folklore. On Wall Street, in party convention centers, NCAA arenas, ivory towers, National Institutes of Health libraries and elementary school kickball fields around the country, data of every sort is collected, chronicled, analyzed and shared. Some reports have more gravitas. These are the ones where standards are clear, consistent and universally accepted. But many reports, such as those involving credit, are understood to have subjective features. Transunion, Equifax and Experian grade millions of us as consumers using slightly different scoring systems. Moody’s, Fitch, Standard & Poor’s and Kroll, rate many thousands of the bonds issued every year using different approaches, drivers, and assumptions.
The Major Credit Raters
We have not had a major national conversation about credit rating agencies since the 2008 financial crisis when we were somehow shocked to learn that they are not a subscriber-pay but an issuer-pay service: borrowers pay companies annually to rate their securities, and the competition for high fees has created or can produce huge pressure among them to issue the highest possible ratings and to NOT downgrade clients or their securities. After the Enron and Worldcom bankruptcies in 2001 and 2002, the Securities and Exchange Commission placed these agencies under active regulation. Five years later when the housing market began to collapse, the full force of legislators and regulators turned those who sold subprime debt along with those who rated it. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act attempted to impose a new regulatory regime on the agencies. It can be debated whether they now provide more accurate information, if investors have a more clear understanding of their criteria and conflicts. For sure, we have seen disclosures and disclaimers that are often many pages longer than the analyses themselves. But we have not openly examined whether the new penalties have perhaps unfairly increased the number of non-investment grade bonds, if the whole revamping effort has effectively led to a big rise in the volume of non-rated bonds, and if so-called default risk assessments have produced unreasonable drops in not only many bond prices but in related stock prices as well.
Evaluating Rated and Non-Rated Bonds
We at HJ Sims work with the major rating agencies and hold in high regard many of the professionals who analyze and report key senior living and charter school medians and ratings. We believe that ratings are unquestionably essential to the efficient functioning of our fixed income markets and the daily evaluations of institutional as well as individual bond portfolios. It was John Moody who supplied the first independent information on railroad bonds in 1909; now, 113 years later, we are trading an average of $13.7 billion of munis and $41 billion of corporates every day in large part relying upon these outside experts with tools and experience to help us assess relative quality and investment risk. But a number of firms including HJ Sims also conduct our own analyses of the many bonds that are rated as well as those that are not rated by a major agency. Your HJ Sims representative can help you find significant incremental value and higher yields in offerings from smaller and first-time issuers as well as from those not interested in or able to pay for credit ratings.
Taking A Close Look at ESG Designations
The next rating sector in the lineup to be scrutinized and regulated is the one involving ESG (Environmental, Social and Governance) designations. There is a multi-decade history of demand for stocks and bonds touting social responsibility, but the validity of ESG designations and ratings has come into question of late. Elon Musk just tweeted in the last few days that “ESG is a scam. It has been weaponized by phony social justice warriors.” The former of responsible investment at HSBC Asset Management also just remarked that the focus on climate is overstated and “disproportionate” compared to pressing concerns like inflation. A host of state officials in states including Utah and West Virginia have begun to publicly criticize ESG as politicized and as “a potentially costly diversion from straightforward financial investment criteria using strategic, fact-based and diligence-driven factors.” They note that the rating companies each have their own metrics with different scoring systems. We hope that a healthy national conversation ensues.
Socially Responsible Investing
Socially responsible investing here in the U.S. is often said to date back to the 1700s when Quakers refused to participate in the slave trade and John Wesley, founder of the Methodist movement, urged his followers to shun profiting at the expense of their neighbors and avoid partnering with those who earned their money through sinful activities. In the 1960s, concerns about the Vietnam War, tobacco production, civil rights, labor and equality issues and associations with the South African Apartheid regime began to change some institutional and retail investor practices. The 1980s saw the arrival of the Domini Social Index Fund, Calvert Social Investment Fund Balanced Portfolio, and the Parnassus Funds. On the global front, there is no doubt that ESG investing has increased exponentially. In 2021, at least 121 new ESG funds and ETFs were launched, adding to the 718 mutual funds and 94 ETFs already on record. Bloomberg estimates that debt issuance exceeded $1.6 trillion last year, and that assets are poised to reach $41 trillion by the end of 2022. A number of ESG-focused special purpose acquisition companies have filed IPOs in the last few years to hunt for targets. So, it is highly unlikely that ESG considerations will be dropped from discussions with either investors or rating agencies.
Impact investing is a discipline familiar to all municipal bond buyers since the first general obligation bond issued by the City of New York for a canal in 1812. One can argue that muni bonds are textbook illustrations of ESG investments but Bloomberg data show that muni issuers sold $49 billion with ESG labels in 2021, about 10.7% of all tax-exempt issuance last year. Most sustainability bonds come from state housing agencies. The majority of green bonds have been issued for college, transit, power and wastewater projects. We are seeing an increasing number of workforce housing and single family mortgage deals that utilize the social bond designation but very few senior living and charter school financing yet. Eligibility screening for the social bond designation places emphasis on non-profit deals financing projects that target populations of the vulnerable and disadvantaged, in medically underserved areas, with significant number of charity cases, and/or where there is a shortage of healthcare professionals. Obvious candidates might include skilled nursing facilities with high Medicaid payor mixes. Green or sustainable bonds would finance projects with composting, EV charging stations, geothermal heating, clean energy purchases, energy savings, CO2 emissions avoided and water management, for example.
Self-Certifications and Paid Verifications
There are only a handful of verifiers active in U.S. public finance at this point, each citing links to international standards and seeking to achieve conformity with key pillars on the use of proceeds, process for project evaluation, management of proceeds, quality of reporting and impact. Standards do, however, differ. As does cost and responsibility for monitoring. Some borrowers including U.S. state and local agencies self-certify, a bold move that raises eyebrows among skeptics. Others pay a fee for independent verification in a process that may add time to the financing schedule. At present, definitions are not precise and requirements are evolving so the markets have a hard time assessing the value of the various stamps and certifications. Major institutional buyers are having to perform their own due diligence using their own criteria. And securities regulators are becoming more involved; the U.S. Securities and Exchange Commission announced this week that it had fined a Bank of New York Mellon advisory unit $1.5 million over alleged ESG disclosure failures.
This Week in Municipal Bonds
This week’s $9 billion municipal bond calendar features six ESG-labeled transactions with combined par of $467 million. No senior living financings are scheduled but in the charter school sector, five deals are planned. There is a $64 million AAA rated state guaranteed Arlington Higher Education Finance Corporation sale for Trinity Basin Preparatory schools in Dallas, Fort Worth and Mesquite. The California School Finance Authority has a $57 million BBB- minus rated deal for Classical Academies Oceanside, and a $51 million BB rated sale for John Adams Academies in El Dorado Hills, Lincoln, and Roseville. The Wisconsin Public Finance Authority plans a $19.4 million non-rated issue for Clover Garden School in Burlington, North Carolina. And the Indiana Finance Authority is bringing a $13 million Ba2 rated deal for Indiana Math & Science Academy in Indianapolis.
Good Signs for the Tax-Exempt Market
May is usually one of the best performing months of the year for tax-exempts but, this time, munis continue to underperform Treasuries. We finally saw some new issues re-price to lower yields last week and secondary offering par is declining – both are good signs. The 10-year muni/Treasury ratio at 101.5% is starting to lure crossover buyers into the tax-exempt sector. The longer end, with the 30-year ratio at 106.1%, is even more attractive. One muni benchmark index eked out a positive return for the first time in seven weeks despite a 19th week of net outflows in mutual funds, the longest stretch of withdrawals since 2014. Mutual funds nevertheless hold $852 billion of assets for investors. Muni buyers looking for a more liquid alternative to mutual funds have added to exchange traded fund holdings for four straight weeks now, $653 million in the last period, bringing assets under management to $86 billion. June redemptions, maturities and coupon income will produce a staggering $65 billion of cash for reinvestment and we encourage you to contact your HJ Sims representative for a lineup of offerings tailored to your investment needs and goals.
At this writing, the 2-year Treasury yield stands at 2.50%, down 20 basis points since the start of the month. The 20-yaer AAA general obligation municipal bond yield at 2.14% has fallen 8 basis points. The 10-year Treasury at 2.72% has tumbled 21 basis points, the 10-year Baa corporate bond yield at 5.26% is up 10 basis points, and the 10-year muni has risen 7 basis points. The 30-year Treasury benchmark yield at 2.93% yield has dropped 6 basis points in May. The comparable muni at 3.15% is 10 basis points higher. The major stock indices are all lower: the Dow has lost 3.2%, the S&P 500 is 4.6% lower, the Russell 2000 has fallen 5.3% and the Nasdaq is down 8.7%. Oil prices at $111 a barrel are up 6% in May. Gold prices at $1,867 an ounce have dipped 1.6%, silver at $21.77 is off by 4.4%. Bitcoin at $29,297 has lost 24%.
Market Movers Ahead of Memorial Day Weekend
Minutes from the last Federal Open Market Committee were released on Wednesday. Traders are focused on this as well as on the big slide in new home sales and other weakening economic data. Durable goods, annualized GDP, manufacturing, personal consumption, pending home sales, jobless claims, personal income and spending, consumer sentiment, and retail corporate earnings will all move markets as we head into the holiday weekend. Inflation and growing fear of a coming recession are causing a shift in expectations on future rate hikes, with many starting to doubt that the Fed will move higher in July. It is hard to see and end to the war in Ukraine, the Covid pandemic rages on, and now there are new monkeypox outbreaks to remind us of the many things that are beyond our control. Primary election results in Alabama, Arkansas, Georgia, Texas and Minnesota, however, remind us that voting matters. The Top Gun sequel, the NHL and NBA playoffs, and all of major league and minor league baseball offer us some welcome entertainment. As we prepare to honor those who have fallen in our nation’s battles, celebrate our newest graduates, and prepare our summer season lineups, we at HJ Sims wish you a long home run of a Memorial Day weekend.
For more information on our municipal offerings or questions about current market conditions, please contact your HJ Sims representative.