Investor concerns over the crises within the financial industry are bleeding into a corner of the $4 trillion municipal-bond market where major investment banks guarantee energy for public utilities.
(Bloomberg) — Investor concerns over the crises within the financial industry are bleeding into a corner of the $4 trillion municipal-bond market where major investment banks guarantee energy for public utilities.
Spreads have widened on so-called prepaid gas bonds, which government agencies use to purchase long-term supplies of natural gas. Large institutional banks act as facilitators of the transactions, guaranteeing the supply and providing investors tax-exempt exposure to bank credit. Now, with global markets on edge over turmoil at Credit Suisse Group AG and the collapse of some US regional banks, those bonds have cheapened.
Unlike traditional municipal bonds that are backed by government revenues like taxes or household utility bills, these securities are more closely correlated to the corporate market on a credit basis. So while the broader municipal bond market has rallied, prepaid gas bonds have underperformed because a key-rating factor is the quality of the bank involved in the transaction.
Debt due in 2038 sold by the Public Authority for Colorado Energy traded at an average spread of 193 basis points on Tuesday, 31 basis points wider than where the bonds changed hands in early February, according to trading data compiled by Bloomberg.
Similarly, a bond sold by the Lower Alabama Gas District due in 2046 traded on March 13 at an average spread of 149 basis points, up from the 60-day average of 139 basis points, according to trade data. And when looking at large-block trading on debt due in 2037 sold by Arizona’s Salt Verde Financial Corp., investors demanded yields 179 basis points over the benchmark on March 13, up from 169 about a week earlier.
Read More About Prepaid Gas Bonds From Bloomberg Intelligence
Quite Low
Because most of these bonds are guaranteed by major Wall Street institutions — Citigroup Inc. guarantees the Salt Verde bonds, while Goldman Sachs Group Inc. provides the assurance for Lower Alabama — the risks associated with the debt are quite low.
“Pre-pay gas bonds have faced some pressure driven by financial sector volatility over the past few days, which makes sense given that banks tend to be among the main guarantors of gas supply in the deals; hence, prepay gas bonds are highly correlated with financials,” wrote Barclays Plc analysts led by Mikhail Foux in a research note published Tuesday. “However, we still see value in the sector.”
“We liked this muni sub-sector going into the current market turbulence and continue seeing value there, especially if the credit spreads of pre-pay gas bonds widen further in sympathy with corporates,” they said.
There’s been a flurry of such deals in recent years, both traditional pre-paid gas transactions and a newer version of the debt where utilities buy decades of renewable electricity. The growth is driven in part by a gap between banks’ financing costs and municipal-bond yields. That’s increased the discounts that public utilities get for buying the energy supply ahead of time.
In 2022, a record $10.3 billion worth of such debt was sold in the muni market, even when issuance broadly had declined from 2021. And another $4.8 billion has been issued in 2023, on pace to break last year’s surge.
“The main participants in prepaid gas deals are the money-center US banks,” which are high quality, highly-regulated and don’t have the asset-liability mismatches seen in the regional banks that are having issues, said Jason Appleson, head of municipal bonds at PGIM Fixed Income.
“We are seeing spread-widening in a market where the fundamentals are clearly so strong — if you liked them when spreads were tighter, you should definitely like them when spreads are wider.”
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