Credit Pipeline

July 28th, 2016 6:22 am

Via Bloomberg:

IG CREDIT PIPELINE: EXIMBK Set to Price, Domestics Expected
2016-07-28 09:26:50.786 GMT

By Robert Elson
(Bloomberg) — Expected to price today:

* Export-Import Bank of India (EXIMBK) Baa3/BBB-, to price
$bench 144a/Reg-S 10Y, via managers Barc/BAML/C/JPM/SCB; IPY
+210 area


* International Business Machines (IBM) Aa3/AA-, filed
automatic mixed shelf yesterday; $2b matured last week
* Analog Devices (ADI) A3/BBB, to raise near $7.3b in debt for
Linear Technology (LLTC)
* Adani Transmission (ADTIN) Baa3/BBB-, mandates
Barc/DBS/NBD/MUFG/Nom/SG/SCB for debut $bench 144a/Reg-S 10Y
* Visa (V) A1/A+; CFO says will issue $2b debt for buybacks by
yr end (July 21); last seen in Dec.
* Nike (NKE) A1/AA-; automatic debt shelf (July 21); has
followed filing with issuance in the past
* American Express (AXP) A3/BBB+; reported earnings July 20
* Said in April that it plans to issue ~$3b-$7b term debt
* Has $2.2b maturing next week; $2.3b in Sept.
* American Express Credit sold $1.75b 5Y notes in May
* The Government of Trinidad & Tobago (TRITOB) Baa3/ A-, has
mandated Deutsche Bank and First Citizens Bank to arrange
investor meetings July 25-27; 144a/Reg-S 10Y offering may
* Empresa Nacional de Petroleo (ENAPCL) Baa3/BBB-, hires C/JPM
to arrange investor meetings July 25-Aug.; 144a/Reg-S USD
10Y may follow
* Export-Import Bank of India (EXIMBK) Baa3/BBB-, has mandated
BAML/Barc/C/JPM/SCB to arrange investor update meetings July
21-27; 144a/Reg-S senior notes offering may follow
* Microsoft (MSFT) Aaa/AAA; exited blackout Tuesday; last
issued in Oct.
* MSFT is acquiring LinkedIn (LNKD) for $26.2b
* Bayer (BAYNGR) A3/A-; “disappointed” $125/shr bid for
Monsanto (MON) A3/BBB+ rejected (July 19)
* $63b financing said secured w/ $20b-$30b bonds seen
* Kingdom of Saudi Arabia (SAUDI), said to have hired 6 banks
to lead first intl bond sale; mtg later this month
* Managers will work with Citi, HSBC, JPM who were said to
be global coordinators for at least $10b of bonds,
divided into 5y, 10y, 30y tranches, similar to Qatar’s
recent sale
* Sumitomo Life (SUMILF) A3/BBB+; investor mtg July 19 via
BofAML; focus to be on hybrid capital
* Last priced a USD deal in 2013
* Woori Bank (WOORIB) A2/A-, mandates BAML/C/Cmz/CA/HSBC/Nom
for investor meeting July 11-20


* National Grid (NGGLN) Baa1/–; investor mtgs June 1-3


* Danone (BNFP) Baa1/BBB+; ~$12.1b WhiteWave (WWAV) Ba2/BB
* Co. Says deal 100% debt-financed, expects to keep IG
profile (July 7)
* Thermo Fisher (TMO) Baa3/BBB; ~$4.07b FEI acq
* $6.5b loans, including $2b bridge (July 4)
* Zimmer Biomet (ZBH) Baa3/BBB; ~$1b LDR acq
* Plans $750m issuance post-completion (June 7)
* Air Liquide (AIFP) A3/A-; ~$13.2b Airgas acq
* Plans to refi $12b loan backing acq via USD/EUR debt
(June 3)
* Great Plains Energy (GXP) Baa2/BBB+; ~$12.1b Westar acq
* $8b committed debt secured for deal (May 31)
* Abbott (ABT) A2/A+; ~$5.7b St. Jude buy, ~$3.1b Alere buy
* $17.2b bridge loan commitment (April 28)
* Sherwin-Williams (SHW) A2/A; ~$9.3b Valspar buy
* $8.3b debt financing expected (March 20)
* Shire (SHPLN) Baa3/BBB-; ~$35.5b Baxalta buy
* Closed $18b Baxalta acq loan (Feb 11)


* Potash Corp (POT) A3/BBB+; debt shelf; last issued March
2015 (June 29)
* Tesla Motors (TSLA); automatic debt, common stk shelf (May
* Debt may convert to common stk
* Reynolds American (RAI) Baa3/BBB filed automatic debt shelf;
sold $9b last June (May 13)
* Statoil (STLNO) Aa3/A+; debt shelf; last issued USD Nov.
2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)
* Rogers (RCICN) Baa1/BBB+; $4b debt shelf (March 4)


* Investment Corp of Dubai (INVCOR); weighs bond sale (July 4)
* Alcoa (AA) Ba1/BBB-; upstream entity to borrow $1b (June 29)
* GE (GE) A3/AA-; may issue despite no deals this yr (June 1)
* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)

Some Corporate Bond Stuff

July 28th, 2016 6:20 am

Via Bloomberg:

IG CREDIT: Long Bonds Most Active on Client Flows
2016-07-28 09:34:15.114 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $17.6b vs $16.8b Tuesday, $19.6b the previous

* 10-DMA $15.9b; 10-Wednesday moving avg $17.4b
* 144a trading added $1.6b of IG volume vs $2.3b Tuesday,
$2.5b last Wednesday

* Most active issues:
* ABIBB 3.65% 2026 was 1st with client and affiliate flows
accounting for 91% of volume
* VZ 4.862% 2046 was next with client flows tacking for
81% of volume
* TAP 4.20% 2046 was 3rd with client selling 8:5 over
* MYL 5.25% 2046 was most active 144a issue with client flows
taking 81% of volume

* Bloomberg US IG Corporate Bond Index OAS at 148.1 vs 146.7
* 2016 high/low: 220.8, a new wide since Jan. 2012/150.8
* 2015 high/low: 182.1/129.6
* 2014 high/low: 144.7/102.3

* BofAML IG Master Index at +148 vs +147
* 2016 high/low: +221, the widest level since June
* 2015 high/low: +180/+129
* 2014 high/low: +151/+106, tightest spread since July

* Standard & Poor’s Global Fixed Income Research IG Index at
+200 vs +196
* +262, the new wide going back to 2013, was seen
* The widest spread recorded was +578 in Dec. 2008

* S&P HY spread at +605 vs +598; +947 seen Feb. 11 was the
widest spread since Oct. 2011
* All-time wide was +1,754 in Dec. 2008

* Markit CDX.IG.26 5Y Index at 73.4 vs 74.5
* 73.0, its lowest level since August, was seen April 20
* 124.7, a new wide since June 2012 was seen Feb. 11
* 2014 high/low was 76.1/55.0, the low for 2014 and the
lowest level since Oct 2007

* Current market levels vs early Wednesday, Tuesday levels:
* 2Y 0.722% vs 0.754% vs 0.742%
* 10Y 1.504% vs 1.563% vs 1.546%
* Dow futures +20 vs +35 vs -3
* Oil $41.83 vs $42.58 vs $42.80
* ¥en 104.64 vs 105.45 vs 104.37

* U.S. IG BONDWRAP: Verizon Brings $6.15b 5-Part Deal Before
* July totals $115.185b, YTD $1.013t

Overnight Data Preview

July 27th, 2016 8:24 pm

Via Robert Sinche at Amherst Pierpont Securities:

EURO ZONE: The Bberg consensus expects the leading Business Climate Indicator to have slipped to 0.17 in July from 0.22 in June; a 0.17 reading would be disappointing but above the 0.12 low for 2016 reached in March. The consensus also expects the overall Economic Confidence Index to have slipped to 103.5 from 104.4, still above the March low of 103.0.

GERMANY: The Bberg consensus expects another -4K drop in Unemployment, keeping the UR at a record low 6.1% in July. Regional CPI reports during the morning will be followed by the National CPI at 8am…with the consensus expecting the July EU Harmonized CPI to inch up to 0.3% YOY from 0.2% YOY in June.

ITALY: Hourly Wage gains for June will follow the record 0.6% YOY rise reported in April and May, with almost flat wages likely contributing to falling Consumer Confidence and weak sales growth.

SPAIN: The Bberg consensus expects the Unemployment Rate for 2Q2016 to have fallen sharply to 20.3% from 21.0% in 1Q.

SWEDEN: The Bberg consensus expects the Unemployment Rate to have slipped back to 7.0% in June from 7.2% in May while Real Retail Sales growth will have slipped back to 4.1% YOY in June from a solid 4.6% surge in May.

UK: The Bberg consensus expects that the Nationwide House Price Index to have slipped to 4.5% YOY in July, lowest since the 4.4% YOY gain in January.

FOMC Analysis

July 27th, 2016 8:20 pm

Via Millan Mulraine at TDSecurities:

TD SECURITIES DATAFLASH                   

US: FOMC Signals “Diminished” Near-term Risks 

  • The July FOMC statement reflects a Fed that has become incrementally more confident in the economic outlook.
  • While the risk assessment remained absent from the statement, the inclusion of the reference to diminished near term risks suggests that the Fed is inching toward re-adopting a tightening bias.
  • The tone of the statement had a somewhat less dovish feel relative to June. However, the absence of an assessment of the risks is an indication that a rate hike might still be some time away. 

The Fed delivered a fairly nuanced message in the July statement, offering only modest changes to reflect the relatively upbeat tone in the economic data, while signaling that the near term downside risks might have eased. Nevertheless, the assessment on the balance of risks remained absent in the statement. The characterization of growth and labor market performance was upgraded marginally, with the economy seen as “expanding at a moderate pace” which represents a more constructive assessment than the June report which stated only that “economic activity appears to have picked up.” Similarly, the labor market assessment was upgraded to reflect the recent strengthening in the payrolls. The inflation assessment was broadly unchanged.

The absence of the risks assessment remains a meaningful signal that Fed is still comfortable on the sidelines, though the inclusion of the reference to “diminished” near term risks suggests that some of the risks factors lurking in the immediate aftermath of Brexit may have abated. Nevertheless, the presence of the reference to the need to “closely monitor inflation indicators and global economic and financial developments” suggests that the medium to longer-terms headwinds to growth are yet to fully abate.

On balance, this was a less dovish statement than the June edition, and it points to diminished downside risks to the economy relative to June. However, the overall thrust of the message is that the Fed remains in a wait and see mode, though the “near term” downside risks to growth are seen as diminished. As a result, we continue to expect the Fed to keep rates unchanged until mid-2017, though a further easing in risk factors and evidence of firming inflation could bring the timing of that move closer. However, there is nothing in this communiqué to suggest that the Fed is prepping the market for a September hike.

Another Duration Lesson

July 27th, 2016 8:15 pm

Via WSJ:

Investors in Japan’s 40-year bond have lost 24 years of coupon income in just three weeks as the rush into long-dated safe government paper went into sharp reverse.

At one level, the 10% fall in the price of the longest-dated Japanese government bond is just a correction after this year’s extraordinary rally, which delivered returns of more than 50% before the pullback.

At another, it highlights something dangerous at work in today’s markets: the scale of the risks investors are willing to take as they try to avoid anything that depends on economic growth.

Japan’s bond selloff was worse than other markets’, as investors prepared for next week’s ¥28 trillion ($268 billion) spending and tax-cut package and a possible further Bank of Japan stimulus this Friday. U.S., U.K. and German bond prices have also dropped since early July, though by less, as global demand weakened for long-duration assets.

The demand for safe assets with a long duration—a proxy for how long it takes an investor to get his money back—was mirrored in stocks and corporate bonds. Rather than search out the highest-yielding assets, investors looked for those with secure yield, even if it was lower. So this year, triple-A-rated corporate bonds have outperformed double-A or single-A bonds, according to Barclays data. The same applied for junk bonds, with the higher ratings outperforming lower ones. (An exception was bonds close to or already in default, which were mainly energy companies and so were boosted by the rising oil price.)

Among U.S. shares, the best-performing sectors were the staid dividend-paying utilities and telecoms, both up more than 20% this year, while utilities rivaled the recovering energy sector as global leader.

Yet, investors are taking very big risks with these long-dated assets, most easily measured for the bonds. Japan’s 40-year bond would fall another 15% in price if the yield rose by just half a percentage point, taking it back to where it stood in March. The same rise for the U.S. 10-year Treasury note, taking the yield back to 2%—merely matching the Federal Reserve’s inflation target—would hit the price of one of the world’s safest assets by 4%, or about 2 1/2 years of coupon income.

The ramp-up in long bond prices this year tells us one of two things. Either investors don’t care about, or don’t understand, the risks they are taking on long-duration assets or they are much more worried about the economy than are economic forecasters.

The truth is probably a bit of both. Bonds have been helped by momentum buyers, who bet purely on price trends continuing. They have also been supported by insurers buying duration to keep up with rising long-dated liabilities, which Kevin Gaynor, head of international research at Nomura, says are “almost forced buyers.” Pension funds are in a similar position, as their liabilities rise when yields decline, pressuring them to buy long bonds to match those liabilities.

At the same time, investors have become more concerned that central banks are running out of ammunition and the world risks being stuck in a deflationary rut. Such an outcome would be great for bonds, even as cyclically exposed equities would be crushed.

The past three weeks in Japan have given a foretaste of what could happen to investors who have been trying to avoid economic risks if they turn out to be wrong. As Brexit worries dissipated, at least outside the U.K., hope for the U.S. economy returned and demand for longer duration weakened. Calls for more fiscal support for economies are being answered by government spending in Japan and a loosening of austerity in Britain, while the European Commission on Wednesday went easy on Portugal and Spain’s breaches of deficit limits.

No one expects a quick return of yields to what once counted as normal—that is, tracking nominal gross-domestic-product growth, forecast by the International Monetary Fund at 3.4% this year for the U.S.

But if yields merely rise back to where they started the year, it would be catastrophic for those who have chased longer duration. The 30-year Treasury would lose 14% of its value, while Japan’s 40-year would lose a quarter of its value, equal to 63 years of coupons. Has the long-run economic outlook really changed so much since January?

June Durable Goods

July 27th, 2016 9:16 am

Via Stephen Stanley at Amherst Pierpont Securities:

The June durable goods report was generally weaker than expected.  The headline figure sank by 4.0%, more than double the drop projected by the consensus.  The bulk of the decline in June reflected a steep plunge in aircraft bookings (Boeing reported a sharp fall in orders after robust April and May figures and in front of the air show in July).  Thus, the weak headline figure is not especially troublesome.  In fact, excluding defense and aircraft, orders managed to post a 0.5% rise, only the second increase in the past five months.  However, even this result is not especially encouraging, as I had anticipated an advance of more than 1% and the year-over-year drop widened to 1.8%, the worst result year-to-date.  The bump in this measure was mainly driven by a sizable rise in the motor vehicle sector, mirroring the industry production data.  Excluding transportation, orders fell by 0.5% vs. consensus expectations of a slight gain (I had a flat forecast).  This aggregate is now down 3.6% on a year-over-year basis.  In short, durable goods orders have been and remain soft.

The core capital goods orders figure managed to creep higher by 0.2%, only the second monthly rise so far this year.  This gauge is also deeply in negative territory on a year-over-year basis (-3.7%).  Businesses have taken a cautious approach toward investment for several years now, so this is nothing new, but I think, if anything, the situation is likely to get worse rather than better in the near term, as many firms that have flexibility in the timing of their investment decisions are likely to sit on their hands until after the election (at which time, they should have a better idea of what the tax and regulatory regime may look like going forward).

Core capital goods shipments disappointed yet again in June, falling by 0.4%.  Even so, the decline in core capital goods shipments in Q2 was modest, especially compared to the double-digit annualized plunge recorded in Q1.  In fact, I believe that the “business investment in equipment” component of GDP could post a small rise in Q2 (capital goods exports were down sharply, so the domestic portion of investment could eke out a gain).  While that result would probably be quite surprising, as noted above, I am not optimistic that we will see any positive momentum until at least after the election.  In any case, the data today were not sufficiently different from my expectations to force an alteration to my Q2 GDP projection (3.3%).  I will send out a full GDP preview today or tomorrow.

Driverless Cars and Insurance Company Revenue

July 26th, 2016 10:41 am

Via WSJ:

July 26, 2016 10:22 a.m. ET
The insurance industry has a $160 billion blind spot: the driverless car.

Car insurers last year hauled in $200 billion of premiums, about a third of all premiums collected by the property-casualty industry. But as much as 80% of the intake could evaporate in coming decades, say some consultants, assuming crucial breakthroughs in driverless technology make driving safer and propel big changes in car ownership.

As the threat approaches, U.S. insurance executives are spending millions and embedding with car companies, testing the technology themselves, and wrestling with whether to lower prices as parts of the autonomous future hit America’s roads.
For the actuaries who set insurance rates, it is a puzzle like no other: How do they prepare for a world of so many fewer auto accidents? In the future, will underwriters be insuring drivers or computer code?

“Change is coming and we need to get ahead of it,” said Allstate Corp. Chief Executive Tom Wilson in an interview. The suburban Chicago insurer is spending millions on research for new products and services that involves more than 200 data scientists and tech experts at a company it founded called Arity.
“It isn’t going to happen tomorrow but it is going to happen soon,” he said.
So far, however, the industry hasn’t made dramatic changes to the way it prices car insurance. Truly autonomous cars are years away from dealer showrooms, and many insurers say there isn’t enough data to determine how much safer even some of the newest “semi-autonomous” gear makes America’s roads.

Highlighting the technological challenges still ahead for driverless-car makers, federal authorities in late June disclosed a probe into the May death of a 40-year-old who was killed while operating a Tesla Motors sedan on “Autopilot.”

For insurers, the key to determining how much to charge remains predicting the likelihood that accidents will happen and how much they will cost in repairs and medical care for the injured.

To get that figure, actuaries know how many billions of miles cars typically are driven and how that translates into accidents—currently estimated at one fatality for about every 90 million miles driven in America. They know that male and female drivers have different crash rates, and age matters. And they know that people who have caused wrecks or have certain traffic violations are riskier to insure.

The rates charged by car insurers are subject to approval by state regulators, who seek to ensure that most of each premium dollar goes to claims and claims-handling costs, not to excessive overhead or profits.

But in a future of autonomous cars, actuaries may have to replace calculations about individuals with issues such as: how often cars are hacked and which parts of the country have better satellite imagery. They’ll also have to identify the safety differences across driverless cars, from Google to Tesla, just as they now know that today’s auto makers have safety features of varying quality.

So far, Google’s self-driving cars have racked up more than 1.5 million miles of testing, while Tesla says Autopilot has topped 130 million miles.

In a report last year, KPMG actuaries estimated an 80% drop in the U.S. accident-frequency rate by 2040. Among its assumptions: By 2020, some fully autonomous cars will be available and authorities will be experimenting with upgrades to road infrastructure to help driverless cars navigate.
Data on semi-autonomous gear remains limited to a small subset of vehicles. One of the few insurers adjusting prices already is Liberty Mutual. The insurer gives discounts for some gear including automatic emergency braking, which halts a car to avert a front-to-rear crash. Liberty Mutual is conducting research on the features with the Massachusetts Institute of Technology, and said discounts vary by feature, state regulation and other factors.

Autonomous vehicles “will certainly drive down the cost of insurance as we think of it today, but…there will be other liabilities associated with intelligent cars that will need to be insured,” Liberty Mutual Chief Executive David Long said in an interview.

Consultants say car insurers such as Liberty Mutual that also sell property and liability policies for business customers may be best positioned. That is because many experts see responsibility for car crashes shifting to auto makers and suppliers if caused by equipment malfunction or hacked software.

As insurers debate the impact of a driverless future, timing remains one of the biggest questions.

KPMG forecasts fully autonomous vehicles to be widely available by 2025, while Deloitte Consulting expects proliferation in the late 2020s.

Deloitte forecasts approximately $200 billion in personal-car-insurance premiums to hold steady for seven or eight years, then slide to about $40 billion by 2040. It projects about $100 billion of this $200 billion could migrate to product-liability insurance and coverage bought by ride-sharing businesses.

Deloitte and KPMG stood by their research when reached after news of the Tesla fatality.
State Farm Mutual Automobile Insurance Co. has positioned itself to get an inside look at the technology as it is being developed. The country’s largest auto insurer is a founding partner at the University of Michigan’s Mobility Transformation Center, whose Mcity lab is a leading test site for driverless gear.

Just as air bags and seat belts did in generations past, increasingly common semi-autonomous equipment is expected to offer significant improvements in safety. Among the most effective is automatic braking, which is in fewer than 10% of cars now but will be standard on new cars by 2022, according to the insurance-industry funded Insurance Institute for Highway Safety.

The Highway Loss Data Institute, a sister organization to IIHS, last year found that 11 front-crash-prevention systems from six manufacturers showed 10% to 15% lower rates of claims for damaging other vehicles, compared with models without the gear.

Surprisingly, the institute found no consistent reduction in claim rates from “lane-departure warning” systems. Researchers had a hunch many drivers found the beeping annoying and were turning off the feature. So they visited Honda dealerships in Germantown, Md., and Alexandria, Va., to take a look at cars as they arrived for servicing.

Of 184 cars, only a third had the feature turned on.

While many in the insurance industry expect the new technologies to improve and proliferate, “we are still operating in an era when car makers are recalling millions of vehicles for the simplest of technology failures: ignition switches, floor mats and air bags,” said Robert Hartwig, president of trade group Insurance Information Institute.

He said many prognosticators with speedy timetables for driverless-car adoption “have drunk too much of the Silicon Valley Kool-Aid.”

Write to Leslie Scism at

Duration Lesson

July 26th, 2016 10:24 am

Via WSJ:

The German Yield Curve is Getting Kinky

Blame the ECB’s era of low rates, which makes 12 years is more expensive than 10

Germany’s yield curve is getting kinky. The European Central Bank’s extraordinarily easy monetary policy has led to an unusual kink in the path of bond yields, with the 10-year bond offering a higher yield than the bond maturing in 12 years.

The shape of yield curves is closely watched by investors, and usually arbitrageurs step in whenever bonds get out of line.

But the speed of rate cuts since the financial crisis has created an odd situation where the bonds maturing further in the future look more attractive to investors, who are paying more than they normally would and so taking a lower yield.


The latest 10-year bond, issued this year, will make no payments until it matures in August 2026. The bonds maturing in 2027 and 2028, having originally been issued in the late 1990s, pay annual coupons of 6.5% and 5.625% respectively.

The normal action of bond markets led the price to rise as rates fell over the past two decades, meaning both still offer a negative yield to maturity. But the higher coupons make the bonds look more appealing as more of the total value will be received earlier. In bond jargon, the 10-year bond – where all the value lies in the final payment – has a longer “duration” than the 11- and 12-year issues, where almost half the value comes from the coupons along the way.

Investors would rather receive their money sooner, which helps to increase the value (and so reduce the yield) of the later-maturing bonds.

New kinks are likely over the next few years as Germany’s new zero-coupon 10-year issues overlap in maturity with high-coupon older bonds, including a 6.25% 2030 maturity.

More important than any kinks is the broader shape of the yield curve. With relatively little difference between bonds maturing soon and those maturing in a decade, the curve is very flat – meaning little extra reward for locking up money for the long run. This is bad for banks, and suggests little faith that the ECB’s easy money will get the region’s economy moving again.

Low Returns Bedevil Pension Funds

July 26th, 2016 10:16 am

Via WSJ:

July 25, 2016 7:16 p.m. ET

Long-term returns for U.S. public pensions are expected to drop to the lowest levels ever recorded, portending deeper pain for states and cities as a $1 trillion funding gap widens.

Twenty-year annualized returns for public pensions in the U.S. are poised to decline to 7.47% once fiscal 2016 results are released in coming weeks, according to an estimate from Wilshire Trust Universe Comparison Service, which tracks pension investment returns.

That would be the lowest-ever annual mark recorded by Wilshire, which began tracking the statistic 16 years ago. In 2001, near the height of the dot-com boom, pensions’ 20-year median return was 12.3%, according to Wilshire.

The dip is intensifying a national debate over whether states and cities can continue to afford pension obligations, as the soaring costs are squeezing budgets across the U.S.

“Many states and local governments may be facing difficult choices if investment returns remain low,” said Keith Brainard, research director at the National Association of State Retirement Administrators. “The money has to come from somewhere.”
Connecticut now allocates 10% of its budget to pay down unfunded pension liabilities that more than doubled in size over the past decade. Chicago’s $20 billion pension-funding hole prompted its credit rating to tumble to junk, a rare low mark for an economically diverse city.
A reminder of how long-term fortunes have turned came last week as two pension bellwethers reported their worst results since the 2008-09 financial crisis.

Weak annual gains for the California Public Employees’ Retirement System and California State Teachers’ Retirement System dropped their 20-year returns below 7.5% investment targets, to 7.03% and 7.1%, respectively. The two funds, known as Calpers and Calstrs, are the largest public pensions in the U.S. by assets and oversee a combined $484 billion for 2.6 million public workers and retirees.

The drop in 20-year annualized returns is significant because officials who oversee retirements for police officers, firefighters, teachers and government workers have long said one bad year or two isn’t as important as the long-term average, and they would earn enough money over decades to pay for retiree obligations.


Those long-term returns have dropped below expectations due in large part to two recessions over the past 15 years and a sustained period of low interest rates. Pension funds invest heavily in fixed-income securities, so the loss of a few percentage points of bond yield hinders their ability to post steady returns.

Funding shortcomings often mean taxpayers or workers are asked to chip in more to account for rising liabilities. Every one-percentage-point drop in investment returns represents an increase of 12% in liabilities, according to the Center for Retirement Research at Boston College.

In Erie, Pa., schools are struggling to afford the basics because pension costs have nearly tripled in the past five years, said city schools Superintendent Jay Badams.
Students in Erie receive stapled copies of “Everyday Mathematics” rather than the hardcover textbook. Two winters ago, 21 buckets were needed to catch all the leaks from the ceiling of a second-grade classroom following a snowstorm. Since 2011, one-fifth of the workforce has been eliminated and three schools have closed.

“Our pension costs have been a major expense that force us to spend less on students and more on employee benefits,” Mr. Badams said.

The increased payments reflect a push to make the required contributions into the state’s retirement systems, following years of failing to do so, according to a spokeswoman for the Pennsylvania Public School Employees’ Retirement System. Pennsylvania is making the full required contribution for the first time in 15 years for the fiscal year that started July 1, the spokeswoman said.

Pennsylvania state leaders are debating whether to pass pension changes that would cycle certain workers into cheaper 401(k)-style plans. Poor returns will trigger a “greater sense of urgency” and “escalates the conversation” around stepping away from the traditional pension, said Pat Browne, a Republican state senator who is involved with proposed changes to the state pension system.

Many states and cities tried to narrow funding gaps following the last financial crisis by passing a series of changes to benefits. But even as those moves were made, a sustained period of low interest rates pulled down returns just as a wave of new retirees started to collect pension checks.

If funding continues to slide, pension critics have more ammunition to argue for more aggressive benefit cuts, said Daniel DiSalvo, a senior fellow at the Manhattan Institute, a conservative think tank that supports 401(k)-style options for public pensions.

“The basic question the public will have is: ‘Didn’t we already reform these systems and shore them up in the wake of the recession?’ ” Mr. DiSalvo said. “But here we are back at square one.”

In California, the incoming head of the largest U.S. public pension isn’t ruling out changes. Marcie Frost, who starts as Calpers’ chief executive in October, said on a July 14 call with reporters that she is an advocate for traditional pension benefits but couldn’t say “whether the full [defined-benefit] plan is…the right plan” for California.

“We always have to think about what options might be out there,” Ms. Frost said. A spokesman for Calpers said Ms. Frost has yet to have meaningful discussions with the retirement system’s board or senior leaders about priorities and initiatives.

Ms. Frost’s comments came days before Calpers said that its fiscal 2016 return was 0.6%, the slimmest gain since the 2008-2009 crisis. Calpers has a funding gap of roughly $112 billion, according to the most recent available data. As recently as last year, Calpers Chief Investment Officer Ted Eliopoulos said in an annual letter that the plan was “reassured by our 20-year investment return of 7.76%,” which exceeded the internal target of 7.5%.

Now, “it is a struggle to have a positive return,” Mr. Eliopoulos said in a media call last week.

The decline in 20-year returns wasn’t surprising after two recessions in the last decade, said Christopher Ailman, Calstrs’ chief investment officer. They were like “Pearl Harbor and the great recession happening in a seven-year time period,” he said.

“It’s a marathon, so the first 10 years our pace was good and strong,” Mr. Ailman said. “The last 10 was more uphill and the pace was slower.”

Five Year Note Auction

July 26th, 2016 9:53 am

Via Ian Lyngen (formerly of CRT Capital):