By Heather Gillers and Gunjan Banerji
The coronavirus triggered a liquidity crisis in municipal bonds,
but the volatility that resulted has been brewing for a decade.
Desperate sellers across most markets sold assets at deep
discounts last month as the spreading new coronavirus left
investors fearful and hungry for cash. Perhaps no investment
flipped from coveted haven to spurned hot potato as quickly as
municipal bonds.
Prices have started to recover as U.S. lawmakers authorized the
Federal Reserve to prop up a wide swath of state and local
government debt. But the marketwide breakdown exposed a new
vulnerability in the nearly $4 trillion municipal market: a
concentration of power and risk resulting from a fundamental shift
in how muni bonds are bought and sold on Wall Street and on Main
Street.
More money than ever is managed by a few financial behemoths
that can swallow large chunks of debt at premium prices and don't
shy away from risk. Meanwhile, the banks and brokers that trade
munis have become less inclined to warehouse debt.
That shift left the market susceptible to extreme volatility
when worried investors fled bond funds, triggering waves of forced
selling with few other buyers willing to pay top dollar. Yields on
10-year bonds doubled in three days, a price drop never seen
before, according to Refinitiv, and the S&P Municipal Bond
Index gave up more than a year's worth of gains. State and local
governments were locked out of the debt market for days and
investors who cashed out likely suffered tens of millions of
dollars in losses. Yields rise as bond prices fall.
Powerful participants in municipal funds such as Nuveen LLC,
BlackRock Inc., Goldman Sachs Group Inc. and Invesco helped the
sector's record run last year. Now, outflows from those same funds
helped fuel a record selloff in the historically safe corner of the
market.
Municipal-bond funds hemorrhaged an unprecedented $28 billion
last month through March 25, with more than half of that money
flowing out of funds managed by those four asset managers,
according to Refinitiv. Nuveen attempted to unload roughly $700
million in munis in a single day, shocking a market where the
majority of trades are $50,000 or less, according to Municipal
Securities Rulemaking Board data.
Those muni holdings had built up over the past decade as it got
easier for investors to buy and sell munis. Money managers now
control nearly $1.6 trillion in munis through mutual funds,
separately managed accounts and exchange-traded funds, according to
data from the Federal Reserve and Citigroup.
To help satisfy investors' hunger for yield, some funds piled
into risky debt, financing projects such as charter schools and
nursing homes. As of February, five money managers control more
than half of the assets in high-yield funds, according to
Morningstar data.
But no manager dominated the competition for junk bonds like
Chicago-based Nuveen. As high-yield assets under management by muni
mutual and exchange-traded funds more than doubled over the past
decade to $136 billion, Nuveen's holdings grew sixfold, Morningstar
data show, making it the biggest high-yield muni money manager.
Nuveen, a subsidiary of asset manager TIAA, controls about
1-in-4 dollars in high-yield muni mutual and exchange-traded funds
as of February, Morningstar data show. In 2018, Nuveen named John
Miller, who ran one of the firm's first high-yield muni portfolios
20 years ago, as its new head of municipals.
When backers of a planned New Jersey amusement park and mall,
American Dream, wanted to raise money about three years ago, Nuveen
purchased $105 million of the amusement-park bonds within days.
Prices on the unrated bonds rose by about 10% over the next three
months as Nuveen, flush with investors' cash, bought up more than
half of the entire $500 million of bonds. A far cry from the
highway and high-school construction bonds that make up the typical
muni portfolio, the attraction includes one of the largest indoor
ski hills in the Western Hemisphere. It opened last October, but
its bonds plummeted mid-March amid coronavirus concerns. The
pandemic has led to the indefinite closure of the amusement park
and mall.
Nuveen also reports holding at least a $1 billion stake in an
unrated train line connecting Orlando, Fla., to Miami--known as
Virgin Trains USA, or Brightline--about a third the total deal. The
firm has accumulated about $1.8 billion of city and school bonds
issued by Chicago, which Moody's Investors Service rates as
speculative grade.
When investors rattled by the spread of the coronavirus began
pulling their money from muni mutual and exchange-traded funds in
mid-March, high-yield funds lost 8% of their holdings to
redemptions in two weeks.
Nuveen had net outflows of $5.4 billion in March through the
25th, more than any other fund. The level of redemptions surprised
even Nuveen's Mr. Miller. He acknowledged that the accumulation of
money in mutual funds contributed to the selloff but said the shift
in sentiment was the paramount reason for the selloff. He said he
still has confidence in his high-yield investments.
"The way people viewed the securities switched...in the blink of
an eye, " he said.
These outflows hit a market that has already condensed in recent
years, as the number of banks and brokerage firms that trade munis
fell by 37% over the past decade, according to Municipal Securities
Rulemaking Board data. Since the last financial crisis, major
brokers have also significantly reduced the maximum amount of
municipal debt they are willing to hold in inventory until new
buyers materialize.
"There's nothing any dealer balance sheet can do when the mutual
funds are getting $12 billion of redemptions a week," said Patrick
Brett, head of municipal debt capital markets at Citigroup.
The plummeting prices had ripple effects in the thinly traded
muni market, where managers revise the value of their portfolios
based on trades of similar securities. Chris Brigati, head of
municipal trading at Advisors Asset Management, said his firm
marked down the value of its holdings for more than a week during
the recent tumult.
Calmed by Congress, muni selling has slowed for now, according
to MSRB data. But with a vast chunk of the market sitting in mutual
and exchange-traded funds that investors can easily exit, another
shock could provoke further outflows, causing prices to plummet
again, analysts and money managers said.
"If they're gobbling up the bonds on the way up, it's a
two-edged sword, " said Little Rock, Ark., investment adviser
Edward Mahaffy, who has been managing municipal-bond portfolios for
35 years. "When people want to exit, the reverse is going to
happen."
Write to Heather Gillers at heather.gillers@wsj.com and Gunjan
Banerji at Gunjan.Banerji@wsj.com
(END) Dow Jones Newswires
April 02, 2020 06:44 ET (10:44 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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