MASTERCLASS: Municipal Bonds - November 2023

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  • 51 mins 14 secs
Three experts share their outlooks for the economy and credit quality, why now could be an enticing time to invest in municipal bonds, and the impact of monetary policy moving forward. They also dive into opportunities in different sectors, the potential repercussions of hybrid work arrangements becoming more permanent, and more.
  • Nicholos Venditti, Portfolio Manager, Municipal Fixed Income Team, Allspring Global Investments
  • Suzanne Finnegan, Chief Credit Officer, Build America Mutual
  • Tom Kozlik, Managing Director, Head of Public Policy & Municipal Strategy, Hilltop Securities Inc

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Jenna Dagenhart (00:06):

Hello and welcome to this Asset TV Municipal Bonds Masterclass. Today we'll cover the impact of interest rates, why now could be an enticing time to invest in municipal bonds and opportunities in different sectors. Joining us now to cover their outlooks for the economy and credit quality, we have Suzanne Finnegan, chief credit officer at Build America Mutual, Nick Venditti, senior portfolio manager and head of the municipal fixed income team at Allspring Global Investments, and Tom Kozlik, managing director and head of public policy and municipal strategy at HilltopSecurities.


Well, everyone, thank you very much for joining us today and kicking us off here. Tom, you've been talking and writing about a generational opportunity in municipal bonds for several months now. How would you summarize the current landscape for investors?

Tom Kozlik (01:00):

It's even better. It's an even more attractive situation now, now that we're almost halfway through the last quarter of the year. As you just mentioned, I have been writing and using words like attractive and appealing, and I think the most recent I wrote, we are seeing generationally enticing levels or generationally enticing yields, and they've just improved from a yield perspective. And so this is one of the things that I've been talking to large institutions, small institutions and wealth managers and retail investors about especially over the last couple of weeks and couple of months, because there does seem to be still some folks who have paused. They've put their money in short-term instruments and or cash, and they're waiting.


That being said, I should have said this before, I want to preface this by saying that I understand why it is that a lot of investors over the last couple of months have in a way they felt either confused or kind of duped or jerked around by what it is that's been happening, especially this process that the Fed has been going since the beginning of 2022. So I do get it, but I am still talking to investors about trying to take this opportunity and use it to their advantage.

Jenna Dagenhart (02:41):

And Nick, I'd love to talk macro for a second here. We had been hearing about and waiting on the most widely anticipated recession in history. But on the other side of things, we've had some strong GDP reads, most recently a surprising 5% or so. Do you think that we're more likely to see economic slowdown or growth as we head into 2024?

Nick Venditti (03:05):

I think we are almost certainly going to see economic slowdown heading to recession for a number of reasons. Look, first and foremost, the yield curve is inverted. And just about every time the yield curve inverts, there's a recession that follows. That's the dumbest of all of the reasons, but it's there. So throw that one out.


I think we're seeing material slowness in a couple of segments of the economy that are eventually going to catch up. Look, if you look at the drivers of GDP going back the last 12, 18 months, it's really been consumption, and a lot of that consumption has been credit card financed. And all of a sudden you are seeing credit card balances as high as they've ever been at interest rates that are as high as they've ever been. And so the days of minimum payment USA are probably coming to an end. If you pair that with the fact that there are other pretty significant burdens being levied on the consumer, like student loan payments, right? People I think are wildly underestimating the impact that's going to have on the average student loan borrower.


We often in the financial world, forget that many of us aren't real people. Real people don't make more than $100,000 a year. In fact, only about one in eight of us makes more than $100,000 a year. Most people make 40. And if your student loan payment is somewhere between $250 and 400 a month, that's $5,000 a year. That's $5,000 a year that's not being spent on Cheetos and stickers and glitter, whatever people buy. But ultimately that's going to have a big, big impact on consumption.


And lastly, we talked about this as we were all getting to know each other. I just moved to Wisconsin three years ago and I bought a house with a 2.75% mortgage rate. I will never, ever, ever sell my house and neither will anyone else who's in that same position. And ultimately, I think all of those factors lead to a weaker consumer and lead us into a recession.

Jenna Dagenhart (05:20):

Turning to you, Suzanne, what's your current outlook for municipal credit quality? I mean, there have not been a lot of downgrade since the start of the pandemic. Do you think that'll continue?

Suzanne Finnegan (05:31):

So I do. I think that the initial concerns that people had at the outset of the pandemic really didn't come to fruition. And I think there were a few reasons for that. The primary revenue sources for most municipalities, not necessarily states, but for municipalities are sales tax and property taxes. And those held remarkably strong during the pandemic. And as a result, municipal revenues held very steadily. We didn't see a lot of big fluctuations.


And then on top of that, to begin with, a lot of municipalities and states came into the pandemic with pretty good balances and in a pretty strong financial position. So their primary revenue sources held well, and then there was an enormous influx of federal aid. And so I think that has helped to kind of smooth things out.


One of the questions of course is did all that federal aid, did it hide any flaws or problems in budgets? And it probably did to some extent. But I think we're not expecting a lot of downgrades kind of across the board. There may be some particular sectors that are going to be more impacted, as Nick was talking about student loans and the cost of higher education, things like that. But we're not really expecting that.


I think one of the other positives about this time period is we are coming off this extremely low interest rate environment, which means that almost all municipal debt was issued as long-term fixed rate. And so there's no big problems with variable rate debts stepping up to higher coupons and creating budgetary problems there. Going forward, we may see that change, but right now most municipal debt has been in fixed rate mode at historically low interest rates. And so I think that also bodes well for a fairly stable credit outlook.

Jenna Dagenhart (07:41):

And what about you, Tom, are you concerned about public finance credit quality considering that pandemic relief was running out and many economists are forecasting that economic growth could slow over the next several quarters, as Nick was just talking about?

Tom Kozlik (07:55):

Yeah, I'm very aware of the situation that Nick was referring to. It seems as though most economists are expecting that growth is really going to slow the last quarter of this year and probably even the first two quarters of next year. I'd say that state and local government credit quality probably peaked a year or two ago. That being said, one of the things that we've talked about in our talks is I've been referring to this golden age of public finance, and I'd say that this golden age of public finance is still going to continue into 2024. I think that state and local governments have never been this prepared from a credit perspective for a potential economic downturn, whether or not the economic downturn actually comes to fruition or not, we'll see, but state and local government credits have never been this prepared.


The fact of the matter is that even though state reserve levels or general fund levels they might've peaked two years ago, but they're still near record highs. And going into COVID, going into the pandemic, when I'm thinking about what was happening with state credit quality in 2017, 2018 and 2019, there were several states that were really having problems. There were several states that were cutting aid to local governments that were cutting aid to higher education institutions. And I think that we've seen a massive turnaround in the last couple of years. And the things that I am concerned about from a credit perspective, I do think that public finance upgrades are going to continue to outpace downgrades. I don't see that happening or that reversing anytime soon.


But what I am concerned about from a credit perspective is I'm concerned about state and especially local governments maintaining structural balance coming out of this reality that they've been experiencing with the federal money. And I'm concerned that on an ongoing basis in the next budget cycle or two, structural balance might be a little harder to attain. So I am watching for that closely, but like I said, I want to reinforce it. I'm going to say it again, that state and local governments have never been this prepared for a potential economic downturn.

Jenna Dagenhart (10:18):

Nick, how do you view the opportunity set for municipal debt for investors today, specifically for tax sensitive investors?

Nick Venditti (10:28):

I agree with Tom, it feels generational. We are talking about yields on muni benchmarks that are well in excess of 4%. And if you are a 37% taxpayer, 4% scales up to in excess of 7. 7. All of your listeners would've done cartwheels down the street just a couple of years ago for 7% yields. And they're here and they're not just here, they're here in low volatility, high fundamental credit quality municipal credit.


Look, I agree with Tom. For much of this year the conversation that we've had, that the financial market has had has been money markets versus fixed income. And that's been a difficult conversation because for a long time, money markets out yielded fixed income and they did it with no risk. And if I can get you a bigger yield with no risk, that's a pretty easy equation to solve. But that's not the case anymore, right? The big move we've seen particularly over the last 30 or 45 days in interest rates has allowed fixed income investors and muni investors in particular to generate cash plus very, very easily. And so in my mind, the question isn't money market versus fixed income on a go forward basis, the question is fixed income versus equities. And if your fixed income is throwing off seven, it takes a lot of pressure off what your equity portfolio has to do in order for you to be successful.

Jenna Dagenhart (12:04):

Before we move on, Suzanne and Tom, I saw you both kind of nod as Nick was speaking there, so I'll let you jump in if there's anything you'd like to add.

Tom Kozlik (12:13):

One of the things that I've been seeing is that there is a psychological barrier, and I think that that's one of the reasons of why it is that... I mean, it's a case by case basis that I'm going investor to investor and talking to them about their situation. In most if not almost all these conversations, there's a psychological barrier that folks have to get through. And once that happens, it's a little easier. But yeah, I was nodding because I absolutely agree with what it is that Nick's talking about, and that's been my experience, especially over the last couple of weeks.

Jenna Dagenhart (12:55):

And Suzanne, hybrid working arrangements are becoming more and more common. So let's talk a little bit about that for a second. And they may be a permanent part of American life it seems. Does that have an impact on municipal credit quality?

Suzanne Finnegan (13:11):

I would say it's not across the board, it's very case by case. I think the one focus that a lot of folks are considering or what a lot of people are thinking about is the impact that it has on commercial office space in big cities. We've gone through a bit of the cycle in muni credited with shopping centers and shopping malls closing and the potential impacts of that on tax spaces for cities. But the commercial real estate, commercial office space particularly, that is going to take a long time to impact and make its way through the system due to the way that most municipalities assess property, and then how long that takes to factor into the tax roles and into the tax dollars. So to the extent that you have big vacancies in commercial office space, very often the assessment and the way that the property taxes are determined is based on the occupancy and the cashflow.


So, people have been talking about could you just convert all this commercial office space to residential? And that is not nearly as easy as it sounds. You have a lot of zoning issues and construction issues and the cost, it's a high interest rate environment. It's a high materials cost environment, so that's not a slam dunk. So I think the longer term impact on property values and real estate taxes, that's going to filter through more immediately. You do see reductions in sales taxes and downtown districts. But by far and large income levels have remained the same, income taxes have stayed stable.


I think one area that is going to continue to struggle a bit is in mass transit because they have to adjust their schedules and their service levels to a very different workforce than they did two years ago or three years ago I guess it is now. They are going to have to think about how to be more efficient and maybe how to price the services differently to be more focused on the Tuesday to Thursday commuting crowd instead of the full five day. But I do think that we're seeing some agencies look at alternative pricing. We're seeing some agencies looking at peak time pricing and others looking to potentially move to less of a fair based revenue model and trying to pull in other resources like regional sales tax, that kind of a thing.

Jenna Dagenhart (16:04):

Tom, do you agree with Nick Bloom who wrote that the five day office week is dead?

Tom Kozlik (16:12):

I'm going to build on what it is that Suzanne was just talking about and expand on the idea or maybe even dive a little deeper into the fact that the Kastle Systems data across all of the cities is really only 50% of what it was before COVID. Those numbers have flat lined over the last kind of year, year and a half. There is a little bit of regional variation in places like Texas and Houston and Dallas. It's a little higher, maybe around 55%. And in places like DC and out West like in San Francisco and Los Angeles, the numbers are a little lower below the average. But I think that 50% number is a pretty good gauge of where things are right now.


That doesn't necessarily mean that 50% of people are working from home, but what we are seeing is a new... And on the one hand, there are people talking about it as being a new paradigm. And I think that the way that Bloom would talk about it is though it's just a trend that has really been going on over the last decade or two, mostly related technology and mostly related to the financial situation. And what I mean by that is work from home started to really increase a little bit more after the great recession. And so I think that whether it's the Kastle Systems data that you look at that shows that the numbers are still only 50% of where they were pre COVID.


The Philadelphia Center City District came out a few weeks ago with some data, and this is not just in Philadelphia but for I think 14 or 15 large cities, the numbers that they were talking about showed that non-resident workers are only coming into those downtown areas for those 14 cities on average 65% of the time compared to where they were pre COVID. So there is a new reality. There's a new kind of work from home hybrid work reality that state and local governments, especially local governments with those big downtown urban centers are going to have to react to.

Jenna Dagenhart (18:34):

Following up on that, Tom, will the work from home and hybrid work reality impact state and local government credit quality you think?

Tom Kozlik (18:43):

So, just again, as Suzanne was talking about, I think there definitely is the potential for some pain from commercial real estate in certain cities. Whether or not the vacancy levels are high yet. For example, like in San Francisco, the vacancy levels aren't extremely high yet, but folks are expecting that commercial real estate is really going to start to be volatile over the next year or two or three.


That being said, state and local government revenues overall, I would describe them as being not just vary but incredibly resilient. After the Great Recession overall revenues, if I remember correctly, they did fall in 2013, 2014 slightly, but then they overall started to come back. But most state and local governments have very well diversified revenue streams. Property taxes are kind of 30-ish percent of overall revenues. And commercial real estate exposure to that portion of overall revenues is typically relatively smaller than even that. And so I think that what's going to end up happening is that even when we're seeing this commercial real estate pain and it is going to cause state and especially some larger local governments there, they're going to have to reinvent themselves to a degree. They are going to change.


And Suzanne is right. It is very difficult to change office buildings into residential buildings. Usually those structures are just not made to be able to do that. There aren't enough bathrooms, the wiring, the plumbing, it's very, very difficult to make those changes. That being said, I think that over years, over a matter of years, there are going to be changes that local governments are going to react to. That being said, I don't think that we're going to see a whole lot of overall credit deterioration as a result of it. I think that, again, state and local government revenues are pretty well diversified. They've got a lot of levers that they'll be able to push and pull and change. They could adjust spending oftentimes as needed. And there's some federal money that still some state local governments have that they haven't spent yet as well. So I'm not expecting massive credit impact from the work from home or the hybrid work or commercial real estate changes, but I am expecting those things to change over the next couple of years.

Jenna Dagenhart (21:29):

Nick, anything you'd like to add?

Nick Venditti (21:32):

Yeah. Look, I think the one thing that we have to keep in mind, especially in fixed income, is we have a tendency to look at credit in a vacuum, right? Credit today is as stronger is as strong or as close to as strong as it's ever been. But the reality is that we don't buy bonds that mature today. We get into bed with these issuers for the next 5 or 10 or 30 years. And so it's really important to think about what the future credit quality of these municipalities is going to be. And while I don't disagree with Tom or Suzanne, I don't think this is Armageddon or catastrophic, but I do think that we are seeing changes take place in our economy, changes take place in how we work.


Look, right now we are doing this interview from multiple different locations and it was incredibly easy. Five years from now, it's going to be even easier. The need to be in New York City or San Francisco or Chicago or wherever is going to diminish. And I think it behooves us to consider that there may be demographic shifts, there may be population shifts, almost analogous to what we saw when manufacturing started to die, people moving out of places in Pennsylvania or Buffalo, New York or Detroit, Michigan. We could see those same kind of migratory patterns over the coming decades. Which doesn't impact anyone today. But again, if you own 30 year paper, it's something I think to at least have in the back of your mind.

Jenna Dagenhart (23:07):

Those are all great points. And beyond work from home and real estate factors, Suzanne, are there other big picture trends that you're watching?

Suzanne Finnegan (23:16):

Yeah, a few. I think that we are still seeing a significant lag in recovery in the hotel and convention center activity that drives a fair amount of value for some of the big cities. We're still seeing slower convention center bookings, and that then translates into lower hotel bookings. So, it's not catastrophic, and it definitely has improved and come back since the absolute low of the pandemic. But it really has lagged most of the other sectors in return to normalcy.


From a technology perspective, we think a lot about what the impact of electric vehicles and hybrid vehicles will have on revenues, especially for states and communities that rely on gasoline tax revenues. We're seeing changes in the way that some states are attempting to tax EVs by changing the registration fees and charges to put in additional fee on electric vehicles because since they're not paying for gas, they're technically not subsidizing their part of using the roads. So we look at that as a little bit of a longer term, but just concerned there are some communities that do issue bonds that are just secured by gasoline taxes. So I think those are kind of on the riskier end.


And then a continuing concern that we've had, when BAM launched in 2012 one of the first things we did was to bring on board a pension actuary because pensions and OPE obligations were, and still are, a big issue for local and state governments. And we've seen a lot of changes and we've seen during this time of prosperity that Tom has been talking about where budgets were pretty flush, we've seen pretty good funding of current pension and OPE liabilities. But in tight times you do see that that's a place where governments try to balance their budget and cut a little bit. So we continue to monitor the pension and OPE impact on governmental credits.

Jenna Dagenhart (25:55):

And moving on to monetary policy, Nick, do you think that the Fed will keep rates higher for longer and what might change this outcome?

Nick Venditti (26:04):

Probably. Right. The Fed seems pretty dead set on controlling inflation down to their numbers, and so far they haven't lied to us yet, right? They've certainly caused a lot of volatility. They like to show up on CNBC and other outlets and say crazy things from time to time. But they have largely followed the policy that they outlined at the beginning of all of this. And so ultimately, I think we are in a situation where rates will be higher for longer. I think the only thing that will change that is when the economy does eventually start to slow down.


But I think investors market participants need to be aware that just because the economy slows down, just because the Fed may start to cut rates at some point in the future, doesn't mean we're going to return to a 2.5% 10-year. The 10-year may be around 4.5 or 5 for the foreseeable future. That is not out of line with historic norms. And frankly, as painful as the last 18 to 24 months have been from kind of an investment standpoint, from a more robust picture, we need an economy that can sustain itself with a 5% tenure. That shows that there is fundamental strength in the economy. And so while short rates may come down as the Fed attempts to stimulate the economy if and when needed, I don't know that you're going to see a lot of relief in the 10-year space are out longer.

Jenna Dagenhart (27:40):

And Tom, is timing important for investors at this point? Should investors wait for more clarification from the Fed before they allocate investment dollars to municipal bonds?

Tom Kozlik (27:51):

Yeah, I think timing is important. I think that from a timing perspective, investors don't necessarily need or should get their money... They don't need to put all their money to work at one time. But I think that they do need to get their money to work. And I don't think that they need to be waiting for more clarification from the Fed. And one of the reasons for that is because there is a lot of nuance with the supply and demand dynamic in municipals. Demand from a big picture perspective has not been strong. Luckily, overall issuance has been pretty low this year in 2023. I haven't put a number on a forecast for 2024 yet, but I'm expecting issuance in 2024 is going to be relatively low also.


And so what in my mind is going to happen is when there is more clarification from the Fed about what it is that the next several months are going to look like from our interest rate perspective, I think that there's going to be a real chase for just bonds, municipal bonds. I remember 2020 and 2021, it was hard to find bonds, and those were years where there was a lot of issuance. We're likely going to be going into another year of down issuance. And this is one of the situations that I'm talking to investors about is that now is a time where you can find a lot of bonds that are not only attractively priced, but they're the bonds from a credit perspective that you want to own. And so that's another argument for why it is that the time to get into the market is right now.

Jenna Dagenhart (29:40):

And Suzanne, we've talked about interest rates and their impact on investors and the value of their portfolios. What about their impact on issuers and their credit quality?

Suzanne Finnegan (29:51):

So as I touched on a little bit earlier, for most municipal credits the vast amount of their debt portfolios right now are fixed rate bonds. And so they have a very predictable debt service schedule, which I think is very good and has really had a positive credit impact. I think, though, as we look at much higher rates, we're starting to see a return to variable rate debt and floating rate notes and things of that sort where people are trying to take advantage of the lower coupon at the shorter end of the curve and take advantage of that and trying to save something on their interest on the bonds. And that's fine for the right kinds of issuers that can manage that kind of an exposure. But it probably also does have a little bit of an impact on municipalities down the road because those higher coupon bonds are going to be much harder to refund in the future.


I think ironically, higher interest rates may turn out to be a very good thing for the pension and OPE obligations that I talked about a little while ago. If the investment returns on more traditional investments in the pension funds and in the OPE funds, if those returns go up, then I think we could see an improvement in the funded ratios, and that would also help to balance municipalities budgets.


One of the things we have seen is pension funds looking for a higher yield, moving into more alternative investments that are a little bit riskier. And so that may not be necessary with a higher traditional interest rate environment.

Jenna Dagenhart (31:49):

Before we move on, Nick, Tom, any final thoughts on interest rates and credit quality in that discussion?

Nick Venditti (31:59):

So look, I'll just add onto what Tom said earlier about time and timing. I think the age-old equity adage applies here that time in the market is more valuable than timing the market. And that certainly wasn't maybe the case in '20 or '21. As he said, everyone wanted bonds because we tend to mistakenly buy high and sell low and buy high and sell low instead of buying low and selling high. But right now you're buying low, and could rates go up from here? Certainly they could. And that might mean that you buy a bond today and regret it 60 or 90 days from now. But I have a hard time believing that if you buy a bond today that you aren't going to feel anything but exceptionally happy a year or two or three years down the road because that dividend stream, that tax-exempt dividend stream, is going to be a very valuable component in your portfolio.

Tom Kozlik (33:00):

I think there's going to be more regret if they don't.

Jenna Dagenhart (33:04):

Yes. Yeah, and it's interesting too, Nick, someone I was hosting recently, I believe said, sing along the lines of we don't know exactly what the Fed will do. However, it's pretty hard to fathom that we would see another 500 basis point increase in rates. So yeah, that's a great point.


Now, Nick, sticking with you, what's your team's outlook on municipal credit?

Nick Venditti (33:30):

I think generally muni credit looks good, echoes a lot of what Tom and Suzanne has said. Again, I do think the one thing you need to keep in mind is that muni credit looks as strong as it does because nothing on Earth says, I love you like cash. And we wrote a $5 trillion stimulus check, and a lot of that money showed up directly on municipal balance sheets and that kind of money hides sins, awful sins in some cases. So many sins that the State of Illinois was upgraded for the first time in 25 years.


Now, look, Illinois is not going to default. It's not. But I think you have to ask yourself as an investor, has Illinois kind of found Jesus or will Illinois be Illinois again, right? They've gotten their fiscal house in order, they've made actuarial required contributions to their pensions because they got a huge influx of cash. Will they continue to do that as that cash bleeds out, or will they revert back to being a state with a long proud history of sending governors to jail? Will they revert back to being a state with consistent budget deficits? Will they revert back to being a state, as Suzanne mentioned, with an unfunded pension liability that's unprecedented in all the space and time? Probably Illinois will be Illinois again.


The New York MTA, Pennsylvania, New Jersey, pick your favorite credit to sort of pick on. They will be what they were in a more normal environment. Again, that doesn't mean they're going to default. It doesn't mean anything terrible, but it does mean that investors should get paid for the risks, not that are present today, but that are going to be present over the life of their holding.

Suzanne Finnegan (35:20):

Yeah, I think one of the big concerns that I've had is that that federal money somehow got translated into operating money. So you should use extraordinary money for extraordinary things, not for your normal operating budget. And so I do think some of that may have been hidden in that people may have come to rely on that amount of federal funds sitting there. And so there may be some budget reckoning that is going to come through the system.

Jenna Dagenhart (35:54):

And Tom, investors have withdrawn billions of dollars from municipal mutual funds to date this year. We've seen negative flows in 9 of the last 10 weeks ending October 25th, whereas over 5.6 billion was withdrawn from municipal funds. Are you expecting investors sentiment to shift anytime soon?

Tom Kozlik (36:16):

I'm not as of right now. I think that investors are waiting for, as we were talking about, more clarification from the Fed. And I think that it plays into this idea of timing that we were just talking about. I think that if investors are waiting for the overall investor sentiment in the market to start to shift, what's going to end up happening is that those billions of dollars are going to flow into institutions, and institutions are going to gobble up those bonds that individual investors right now can go out and get. And if anything, I think that this plays into the timing question that we were just talking about.


But the answer is that I'm not expecting that investor sentiment overall is going to shift. That being said, when investor sentiment does finally shift, at that point, it could very well be, I mean, not necessarily too late, but right now there are going to be better opportunities for investors to be able to find bonds. And so again, I'm reinforcing the idea that I don't think that investors should be waiting.

Jenna Dagenhart (37:28):

Suzanne, the municipal market is very diverse in terms of the types of borrowers. It's more than just states and cities. Are there any sectors that you're watching closely?

Suzanne Finnegan (37:40):

I think obviously mass transit is a sector that we continue to watch closely. To some extent, all transportation credits. I think that we've seen the airport sector come roaring back very successfully. But, toll roads are still working their way through as commuter patterns have changed and we've seen some changes in toll schedules and the way that tolls are charged.


I think we've also sort of unexpectedly, we had expected during the pandemic to see an uptick in enrollment in community colleges because typically in bad times people go to community college, and we did not see that at all. In fact, we saw declines in enrollment. A lot of community colleges, their bonds are secured by other sources of revenue, so you're not relying on tuition. But I thought that was an interesting and unexpected segment.


We also are looking, and I won't steal all of Tom's thunder, but we do watch the healthcare and higher ed sectors for a variety of reasons. Healthcare coming off the pandemic and still struggling with the very real and very expensive labor costs and higher ed dealing with demographics that are kind of going against them. But I know that Tom has a particular focus, so I don't want to step on all of his.

Jenna Dagenhart (39:22):

Yeah. Tom, I'll turn to you on that one. I know in the past you've had some concerns around education and healthcare. Are you still worried about those sectors?

Tom Kozlik (39:32):

I'd say concerns and opportunity. But the concerns, as Suzanne was just talking about, I think that demographic shifts are really not starting to, they have been changing for several years what's going on in higher education. That doesn't necessarily mean that investors should stay away from higher education, but they need to be careful. They need to be very selective with what it is they're looking at in the higher education sector.


And I agree with what it is that Suzanne said about the pain and the pressure in the healthcare sector, that exists. But there's still some opportunity in the healthcare sector as well. So my message to investors is not necessarily to stay away from those sectors, but you do have to be careful, and credit selection is very important.

Jenna Dagenhart (40:17):

Nick, I saw you nodding your head.

Nick Venditti (40:20):

Yeah. Look, I'm an active portfolio manager, so you should take everything I say with just heaping grains of salt. But ultimately, I think this is a commercial for active portfolio management. As you mentioned, the municipal market is big and diverse. There's 50 plus, 60,000 individual issuers. There's well over a million CUSIP, right? It dwarfs the equity market. It dwarfs the global equity market in terms of number of names. And by virtue of that, it dwarfs that in terms of number of stories. And so I think Tom mentioned it as it relates to healthcare. Suzanne mentioned as it relates to transportation, not all of these names are equal. And so being able to tear these things apart from the bottom up, understand the fundamental credit quality and marry that fundamental credit quality with relative value to ensure you're buying the right bond at the right price at the right time, ultimately is a big differentiator in portfolio returns.

Jenna Dagenhart (41:24):

Nick, sticking with you here. How should investors think about short duration bonds in their portfolio mix relative to opportunities out the curve?

Nick Venditti (41:34):

Look, short duration looks awfully attractive right now. Again, I think the argument's been money markets versus fixed income. That was a hard, hard argument to win. It's not anymore. You can find short duration muni portfolios that on an after tax basis or yielding 7, and for those of you keeping track at home, 7 is bigger than 5.40, which is the rate you're getting on your money market today. And if I can get you 150, 160 basis points of additional yield for incrementally more risk, that's a good trade. That's the type of trade people need to be making.


Now, on the flip side, the question would be why not lock in those yields for as long as you can, especially if we think the Fed is going to lower rates at some point in the future. I think there's certainly value to that argument. I'm a little less bullish taking excessively long duration, largely because the yield curve is wonky shaped, for lack of a better term for a yield curve that looks like this, right? There is a big, big inversion. And practically what that means is that any day, any day this year, any day likely for the rest of this year, I can go out and buy a 20-year bond that yields 95, 97% as much as a 30-year bond, but has about 80% of the risk. That's a good trade, get paid for risk. And if you can get the same compensation for less risk, that's a great idea. So I'm okay if investors want to step more aggressively into duration, but don't do it so aggressively that you have to buy 30-year bonds because that's the least attractive part of the curve in my mind right now.

Jenna Dagenhart (43:25):

And let's talk a little bit about bond insurance, Suzanne. The use of bond insurance has become more common in the market since the pandemic. What's driving that?

Suzanne Finnegan (43:36):

I think back in the heyday of bond insurance, when there were seven companies and 50% of the market was insured, bond insurance became credit substitution instead of credit enhancement, and people stopped looking through to the underlying credit. I think since that time and especially since the pandemic, I think that more investors are utilizing bond insurance as a tool to reduce volatility in the evaluations in their portfolios.


So interestingly, since the beginning of the pandemic, our fastest growing segment of insured bonds or bonds, that where the underlying rating is in the AA category, so AA minus credits, which you wouldn't think needed insurance. But there was such volatility in the market and the insured bonds tend to hold their valuations compared to uninsured. And so I think that was a big part of that growth, and that's continued now. Post pandemic portfolio managers are appreciative of the tool and of the reduction in volatility. And so we've continued to see very strong insurance in the AA minus range.


I would say the other thing that happened is insurance was considered in sectors that no one had really any interest in insuring in the past. So, we were approached during the pandemic on a lot of airport credits. And prior to the pandemic, no airports were getting insured because they didn't need it. Investors understood the sector and liked it. And there were some airports that were not great candidates during the pandemic, but most airports had tons of cash going into the pandemic. We even saw some airports accelerate construction programs, since the terminals were fairly empty they could get their projects done more efficiently. And so that became a big sector where people were interested in insurance, again, because took out some of the volatility, but it hadn't even been considered prior to that. And we're seeing, again, that penetration rate, the insured penetration rate as staying up where it had been during the pandemic.

Jenna Dagenhart (46:06):

Turning to you, Tom, are there specific types of municipal bonds that you like or prefer over others? And does it make more sense for investors to consider a general obligation over revenue bonds, for example? Or are there specific sectors that you prefer right now?

Tom Kozlik (46:24):

I'm going to make two points where that's concerned. I think the first is that, as Nick was talking earlier, yields have risen so far, so quickly, and they're so attractive now, those geos and revenue bonds that are amongst the highest credit quality, those yields are so attractive that it almost doesn't make sense to take additional risk and to go further out on the risk spectrum because investors might not be getting paid the appropriate amount for taking that additional risk. But also, I think that just the yields for a lot of the state and local governments that are of the strongest credit quality, I mean, they are so attractive right now. That's the first point that I wanted to make.


The second, and this is also building on some of the things that both Suzanne and Nick have been talking about, considering the credit situation that we're in, credit quality is overall pretty strong. I think that there are some credits out there that if I was looking at someone's portfolio, I would advise them to potentially trade out of a credit and get into something else that most likely over the next two, three, four years is probably not going to be having as difficult a time maintaining their structural balance. And so this is a great opportunity for investors to be able to do that.

Jenna Dagenhart (47:59):

Well, before we wrap up this panel discussion, I'd love to go around the room and give everyone a chance to share any key takeaways or final thoughts with our viewers. Suzanne, would you like to kick us off?

Suzanne Finnegan (48:11):

Sure. I think all three of us have agreed that the municipal market is very sound from a credit perspective, but that it is a very big market and a very diverse market with lots and lots of issuers. And so I think it's a market that people need guidance and need to understand what they're getting invested in.


One of the things that Nick mentioned earlier was that these are long-dated positions, typically in long-dated bonds. And at Build America our CEO always likes to say that we are married to the bonds we ensure without hope of divorce. So we can relate to that and definitely recognize that the credit quality can change over the long term. But fundamentally, I think it's a very sound segment of the market,

Jenna Dagenhart (49:19):


Nick Venditti (49:21):

Yeah, look, I hate to sound like a commercial for municipal bonds, but the reality is that if you rewind the clock two years ago, I was in conversations with investors, with retail financial advisors, with institutional consultants, and every one of them asking me the same question over and over and over again. And it was a question that frankly, it hurt my feelings a little bit because I'm kind of a delicate flower. And that question was, is the 60/40 portfolio dead? Is it dead? Is it dead? Because no one wanted to own fixed income. And so today, I will tell you, the 60/40 portfolio is dead. Your portfolio should be 40/60 or some big number in fixed income because the opportunity, to borrow Tom's word, feels generational to me.

Jenna Dagenhart (50:15):

Tom, I'll give you the final word.

Tom Kozlik (50:18):

Yeah. Credit quality is amongst the strongest I've ever seen, and yields are generationally enticing, so don't wait.

Jenna Dagenhart (50:28):

Yeah. Well, great advice and everyone, thank you so much for joining us today.

Tom Kozlik (50:33):

Thanks, Jenna.

Nick Venditti (50:36):

Thank you.

Suzanne Finnegan (50:36):

Thank you.

Jenna Dagenhart (50:36):

And thank you to everyone watching this Municipal Bonds Masterclass. Once again, I was joined by Suzanne Finnegan, chief credit officer at Build America Mutual, Nick Venditti, senior portfolio manager and head of the municipal fixed income team at Allspring Global Investments, and Tom Kozlik, managing director and head of public policy and municipal strategy at HilltopSecurities. And I'm Jenna Dagenhart with Asset TV.

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