A visit with BlackRock’s muni managers

By Cate Long
June 9, 2014

BlackRock

The New York offices of BlackRock, the giant fund manager, crackle with the energy of money. BlackRock is the largest fund complex in muniland, with over $100 billion in municipal fund assets along with undisclosed amounts of separately-managed accounts that hold municipal bonds.

Peter Hayes leads the BlackRock Municipal Bonds Group. He is also a member of the Americas Fixed Income Executive Team and BlackRock’s Global Operating Committee. Hayes is muniland’s biggest kahuna. When he and his team talk, people listen.

Hayes, BlackRock’s head of municipal credit research Jim Schwartz and head muni strategist Sean Carney hosted reporters for a discussion last week.

Hayes said that muniland was oversold at the end of 2013. Now he is seeing a bigger crossover presence chasing yield. Crossover refers to non-traditional buyers who don’t use the municipal tax exemption.

Tax hikes on high income earners have helped produce steady muni fund inflows since January 15, according to Hayes. BlackRock has also had good growth in separately managed accounts (SMA). Muniland issuance is down 25 percent in 2014. Relative value is lower than the pre-crisis level, and Hayes says we may be in this environment for the duration of 2014. It is the strongest technical environment in some time, says Hayes.

Before its downgrade to junk status, Puerto Rico was 10 percent of high-yield indices. Now it is about 22 percent, says Carney. There is a significant amount of zero coupon bonds that skew the indices. Hayes says that Puerto Rico bought about a year’s liquidity with the March $3.5 general obligation (GOs) offering. If there is a debt moratorium, it will ripple through all the Puerto Rico credits.

All three are uniform in their concerns about state tax revenues. Schwartz is closely watching Puerto Rico, Detroit, the Illinois budget negotiations and Connecticut, which has high debt. Overall in the U.S., state sales tax revenues were up only 1 percent year over year. Personal income taxes were down 0.5 percent, which was anticipated after personal gains were loaded in 2013 due to federal tax changes.

Schwartz believes that Detroit could have mediated COPs outside of bankruptcy and saved $100 million of legal fees. There has been no definitive legal decision on GOs in Detroit. He said the Illinois legislature had some fictitious budget numbers and that the state’s payables would go up from $5 to $10 billion again as a way to manage revenue shortfalls.

Schwartz echoed a statement made by Hayes about Puerto Rico buying time, but not fixing its problems. Puerto Rico now provides too much information and needs to be better organized. PREPA, the electricity monopoly, is the first issue that needs to be addressed. My sense is that Blackrock is keenly interested in buying Puerto Rico bonds when the situation stabilizes, but there are too many unknowns to do so now.

Small rural hospital issuers may have a rough year, says Schwartz. The new healthcare act is drawing revenues away from them. Nevertheless, demand for new bonds is so strong that a recent $60 million Texas hospital deal has $1 billion of orders.

Chapter 9 cases are another variable in muniland that have left a lot of uncertainty about general obligation bonds. You don’t know where you stand until you get in front of a specific judge, says Schwartz. Dealing with different underlying state laws and constitutions makes these situations more complex.

Hayes mentioned taking a recent driving tour of New York City and was astonished at how much residential building was happening and how helpful that will be for the city’s tax base.

Overall, the duration ofmuniland is down to 15.3 years from 16.3 years in 2013. This is due to shrinking issuance.

BlackRock has been buying MCDX municipal credit default indexes to hedge portfolio risk, but very few single names (credit default swaps that insure against default for a single entity like California or New York City). The MCDX indices have been more liquid since Puerto Rico brought its March GO deal because hedge funds have been more active players in muni credit default swaps.

BlackRock has also been buying in the secondary market where possible. The company changed the mandate of its intermediate municipal mutual fund to allow the purchase of taxable (corporate) bonds. The fund now has about 3 percent corporate bonds.

Hayes said that it is hard to see outflows beginning again unless interest rates go up or investors start taking gains. Muniland has gotten so rich, it is hard to sustain these high-fund inflow levels.

PHOTO: BlackRock’s reception area CATE LONG

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