May 2, 2017 | Fixed Income Strategy

Municipal Bond Market Weekly

Bottom Line:
The Treasury market had a mild bear-steepener mostly on Mondays tail-risk relief of the French
election. Economic data and tax reform skepticism kept yields range bound.
Municipal yields rose, underperforming Treasuries, with the AAA GO Ratio rising.
Tax reform impact possibilities outlined.
Municipal bond fund flows were positive.
Puerto Rico GO and COFINA bondholders reject restructuring offer details in Puerto section.
S&P Puerto Rico Total Return Index was -0.8% last week; -0.8% YTD.

What Happened in the Bond Markets Last Week?

Last week, Treasury yields had a mild bear-steepener. Yields rose sharply on Monday after the results of the
French election minimized the tail risk associated with an eventual adverse (to markets) outcome (but, you
should have seen the dive in equity implied volatility). During the rest of the week, yields jostled around inside a
relatively tight and oscillating range. Weak relative to expectations economic data including Fridays Q1 GDP
kept yields from moving much higher. The administrations supply-side tax outlined bullet points werent enough
to move yields higher than the range within which they remained for the rest of the week; if anything yields fell
on apparent skepticism. The current probability for an increase in the Fed Funds rate this week at the FOMC
meeting is 14% and 68% for June.
Municipal yields also moved higher, underperforming Treasuries. The 10-yr AAA GO Ratio rose to 94.7.
Yields (Figure 1)

For the week ending 4/28/17 Treasury yields traded higher; 2-year Treasury Note yields +8.2 bps to 1.26%, 5-
year Notes yields were +5.8 bps to 1.81%, 10-year Notes yields were +5.0 to 2.28% and 30-year bonds yields
were +5.9 bps at 2.95%.

Bloomberg Municipal Index curve yields were higher: AAA-rated GO yields; 2-year bonds were +3 bps to
1.01%, 5-year bond yields were +4 bps to 1.45%, 10-year bond yields were +10 bps at 2.16% and 30-year
bonds were +12 bps at 3.01%.

The Ratio of 10-year AAA GO debt to 10-year Treasury yields rose to 94.7 from 91.7 last week. The year-to-
date average is 95.2 and the 12-month average is 94.2.
.

David N. Violette, CFA

Sr. Fixed Income Analyst
Vice President
dviolette@rwbaird.com
414-298-7688
1o
 May 2, 2017

Figure 1 - Yield Curve and Muni Curve Changes Data Source: Bloomberg

One can observe these changes by looking at how rates have changed along the curve for both the Treasury curve and
for the AAA-rated G.O. Index since last week. The top panel shows four yield curves; two for the Treasury curve (in red)
- one for the most current date and one from last week and two for the AAA-rated G.O. (in blue) - current and last week.
The bottom panel of the graph shows changes in the rates along both curves for the week for both Treasuries and the
AAA G.O. Index.
Figure 2 - Muni Ratio Data Source: Bloomberg

AAA 10-Year G.O. Muni Ratio to Treasury

110.0

105.0
Ratio (%)

100.0

95.0
94.7
90.0

85.0

Mid Price SMAVG (50)

2o
 May 2, 2017

Bond Buyer Indexes (Table 1 and Figure 3): Last week, the Bond Buyer Index yields were strongly higher: Bond
Buyer 20-GO Index was up +11 bps to 3.82% and the 25-Revenue Index yield was +11 bps to 4.02%.

Table 1 - Bond Buyer Indexes Source: Bloomberg

Index Yield % Yield Last Week 1 Week Change (bps) Yield 1 Month Ago 1 Month Change (bps)
Bond Buyer 20 Gen'l Obligation Index 3.82 3.71 11.0 3.91 -9.0
Bond Buyer 11 Gen'l Obligation Index 3.33 3.22 11.0 3.42 -9.0
Bond Buyer 25 Revenue Index 4.02 3.91 11.0 4.08 -6.0

Figure 3- Bond Buyer Indexes - 1 Year; Data Source: Bloomberg

Bond Buyer Indexes

1 year
4.5
4
Yield (%)

3.5
3
2.5
2

Bond Buyer 25 Revenue Bond Buyer 20 General Obligation

Supply (Figure 4) Bloomberg 30-Day Visible Supply currently stands at $13.7 billion up from $13.1 billion this time
last week. The YTD average visible supply is $10.9 billion and the 12-mo average is $12.3 billion.

3o
 May 2, 2017

Figure 4- Bloomberg 30-Day Visible Supply - 1 Year; Data Source: Bloomberg

Bloomberg 30-Day Visible Supply
U.S. Total

30,000

25,000

20,000
$ Million

15,000

10,000

5,000

Articles of Interest
Municipal Fund Flows: According to Lipper data municipal bond funds had net inflows of $144.5 million after net
inflows of $290.2 million during the previous week. The four-week moving average is $443.8 million. High-yield funds
had net outflows after inflows during the previous week. ETFs had net outflows.
Trump Tax Points: Last week the Trump Administration revealed their page-long tax reform plan. While lacking detail,
proposals in the plan, if they remain, can give some clues as to their potential impact on municipal bonds. As highlighted
in a Bloomberg Brief article three major ways that the proposals can impact bonds are 1) all else equal, lower taxes
particularly to the highest income earners, would equate to lower demand for municipal bonds as the tax-exemption
would carry less value. 2) The proposal to phase out the Alternative Minimum Tax would increase demand for currently
outstanding AMT bonds which according to Bloomberg pay on average about a half a percent higher yield than non-
AMT bonds. 3) With an elimination of state and local tax deductions from federal taxable income, there would be more
demand for municipal bonds in high income tax states (NY, CA, and NJ). Of course, the bullet points of the plan will be
met with plenty of resistance so, this is all quite preliminary.
Puerto Rico:
st
o Bondholders Reject Restructuring Offer: Days before a May 1 deadline, bondholders rejected the islands
first debt-restructuring offer. Offers were made for general obligation bonds at 77 cents on the dollar and 58
cents on the dollar for sales-tax revenue bonds (COFINA). The offer does not offer higher recoveries for senior
COFINA bonds than subordinate COFINA bonds. In the offer, investors would exchange their bonds for two
new issues including tax-exempt senior bond securities with a maturity of 30 years and cash-flow bonds that
would be repaid after senior securities subject to liquidity. This translates to recoveries to general obligation
holders of 52% for the senior bonds and 77% if all were repaid; the recovery to COFINAs would be 39% for the
bond portion and 58% including the cash-pay portion.
o The S&P Municipal Bond Puerto Rico Index finished at 176.6 on Friday vs. 175.4 at the end of the previous
week, +0.7%. Year-to-date the index is 0.0%%.

4o
 May 2, 2017

S&P Municipal Bond Puerto Rico Index Level (1-year)

Relative Value by Maturity

Table 2 - AAA Muni Ratios and Spreads by Maturity - Data Source: Bloomberg
5/1/2017 Yield-to-Maturity (%) 0% Tax Rate 35% Tax Equivalent
Maturity (yrs.) AAA Gen. Oblig. Treasury Spread (bps) Ratio (%) Spread (bps) Ratio (%)
1 0.84 1.06 -22.2 79.1 23.1 121.7
2 1.01 1.27 -26.2 79.4 28.3 122.2
3 1.18 1.46 -28.1 80.7 35.3 124.2
4 1.30 1.70 -39.7 76.6 30.3 117.8
5 1.45 1.83 -37.7 79.4 40.5 122.1
7 1.78 2.11 -33.5 84.1 62.1 129.4
10 2.16 2.29 -13.0 94.3 103.5 145.1
15 2.60 2.40 20.0 108.3 159.7 166.7
20 2.86 2.67 18.8 107.0 172.7 164.7
25 2.96 2.82 14.0 105.0 173.2 161.5
30 3.02 2.96 5.5 101.8 168.0 156.7

5o
 May 2, 2017

Figure 5 AAA General Obligation Ratios and Spreads Data Source: Bloomberg

AAA G.O. Muni Ratio and Spreads

(0% Tax Convention)
120.00 30.0
110.00 20.0
10.0

Spread (bps)
100.00
0.0
Ratio %

90.00 -10.0
80.00 -20.0
-30.0
70.00
-40.0
60.00 -50.0
1 3 5 10 20 30
Maturity (yrs.)

Ratio (%) (Left) Spread (bps) Right

Relative Value by Rating

Figure 6 Muni Index Yield Curve by Credit Rating Data Source: Bloomberg

4.00
Muni Yields by Rating
3.50

3.00

2.50
Yield (%)

2.00

1.50

1.00

0.50

0.00
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

Treasury AAA AA A

6o
 May 2, 2017

Figure 7 Muni Index Ratios by Maturity and by Credit Rating Data Source: Bloomberg

165 Muni Ratios by Rating

145
Ratio (%)

125

105

85

65
2 4 6 8 10 12 14 16 18 20 22 24 26 28 30

AAA AA A

Figure 8 Muni Index Spread to Treasuries by Maturity and by Credit Rating Data Source: Bloomberg

100.00 Muni Spread (bps) by Rating

80.00

60.00

40.00
Spread (bps)

20.00

0.00
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
-20.00

-40.00

-60.00
AAA AA A

For more information please contact your Financial Advisor.

7o
 May 2, 2017

Appendix Important Disclosures

Some of the potential risks associated with fixed income investments include call risk, reinvestment risk, default risk and
inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bonds price
and its yield. Bond prices will fall as interest rates rise and vice versa.

When considering a potential investment, investors should compare the credit qualities of available bond issues before
they invest. The two most recognized rating agencies that assign credit ratings to bond issuers are Moody's Investors
Service (Moodys) and Standard & Poor's Corporation (S&P). Moodys lowest investment-grade rating for a bond is
Baa3 and S&Ps lowest investment-grade rating for a bond is BBB-. Ratings are measured on a scale that ranges from
AAA or Aaa (highest) to D or C (lowest).

The Bond Buyer 20-Bond Index consists of 20 general obligation bonds that mature in 20 years. The average rating of
the 20 bonds is roughly equivalent to Moody's Investors Service's Aa2 rating and Standard & Poor's Corp.'s AA. The
Bond Buyer 11-Bond Index uses a select group of 11 bonds in the 20-Bond Index. The average rating of the 11 bonds is
roughly equivalent to Moody's Aa1 and S&P's AA-plus. The Bond Buyer Revenue Bond Index consists of 25 various
revenue bonds that mature in 30 years. The average rating is roughly equivalent to Moody's A1 and S&P's A-plus. The
indexes represent theoretical yields rather than actual price or yield quotations. Municipal bond traders are asked to
estimate what a current-coupon bond for each issuer in the indexes would yield if the bond was sold at par value. The
indexes are simple averages of the average estimated yields of the bonds, are unmanaged and a direct investment
cannot be made in them.

This is not a complete analysis of every material fact regarding any sector, municipality or security. The opinions
expressed here reflect our judgment at this date and are subject to change. The information has been obtained from
sources we consider to be reliable, but we cannot guarantee the accuracy. Municipal securities investments are not
appropriate for all investors, especially those taxed at lower rates. The alternative minimum tax (AMT) may be applicable,
even for securities identified as tax-exempt. It is strongly recommended that an investor discuss with their financial
professional all materially important information such as risks, ratings and tax implications prior to making an investment.
Past performance is not a guarantee of future results.

This report does not provide recipients with information or advice that is sufficient on which to base an investment
decision. This report does not take into account the specific investment objectives, financial situation, or need of any
particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report
as a single factor in making an investment decision. Additional fundamental and other analyses would be required to
make an investment decision about any individual security identified in this report.

ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST BY

CONTACTING YOUR BAIRD INVESTMENT PROFESSIONAL.

Copyright 2017 Robert W. Baird & Co. Incorporated.

8o