Municipal Market Performance and Benchmark Rates: Fixed income markets in May were defined by extraordinary whiplash, as the multi-week bond rout abruptly reversed to an eleventh-hour relief rally that saw long-end UST yields fall by over 20 bps. Driven by Middle East energy shocks, persistent inflation concerns and shifting expectations regarding future Federal Reserve leadership and policy direction, long-dated treasury yields briefly touched 5.20%, levels not seen since 2007, before ultimately ending the month unchanged at 4.97%. The municipal market demonstrated sustained relative strength in May, outpacing the U.S. Treasury market for the second consecutive month. AAA benchmark yields were little changed, with the 30-year rate finishing flat and the 10-year rising just 2 bps. Historically, May is a favorable month for municipals as investors move beyond April tax-related selling pressures and position for the favorable technical backdrop that often accompanies the summer months. This May was no exception, as both investment-grade and high-yield indices posted positive returns, with HY outperforming IG for the fifth consecutive month.
The Bloomberg Municipal Bond Index (LMBITR) returned +0.37% in May, extending year-to-date returns to 1.34%. The Bloomberg Municipal High Yield Index (LMHYTR) delivered +0.63% during the month, lifting year-to-date gains to 2.72%
Mutual Fund Flows: Given the retail dominated nature of the municipal market, mutual fund flows remain a powerful technical catalyst. As of the end of May, year-to-date mutual fund bond inflows represent the second highest level on record. Municipal bond funds have now posted 25 inflow weeks over the last 27 with YTD totals approaching $40B. Bond funds experienced inflows each week in May, totaling over $7B, a figure likely to rise further as monthly-reporting funds publish their respective totals. Elevated absolute and tax-equivalent yields and strong credit fundamentals, broadly, have continue to prove compelling for investors.
Primary Market Supply: The municipal primary market is also challenging records as new issue supply is currently tracking 5% above 2025 levels, which set an all-time historical record. New issue supply totaled $55B in May, +5% YoY, and 33% higher than the trailing 5-year average for the month. Non-rated issuance has been relatively lackluster – especially considering overwhelming demand -- but calendars from the underwriting community point to a building summer calendar that hopes to provide ample investment opportunity.
June marks our 16th anniversary of managing non-rated municipal bond portfolios for our clients.
LCP was founded by longtime friends whose careers followed parallel paths in municipal finance and commercial real estate securities origination. The partnership began during the financial crisis after Dave was unable to purchase a block of high-yield municipal bonds Bob recommended for his personal account.
Ironically, the firm unwilling to sell Dave tax-exempt bonds backed by Marathon Oil at 9.25% was more than willing to sell him essentially the same fully taxable exposure backed by Marathon Oil at 9.00% .
That experience ultimately became the foundation of LCP: The belief that inefficiency and limited access in the non-rated municipal bond market can create compelling opportunities for taxable investors and that access to those opportunities should not be limited to institutions alone.
One constant throughout our 16-year history has been the meticulous credit process we built for underwriting and managing portfolio credits. Dave's commercial real estate background brought a healthy skepticism to financial projections and feasibility studies, we have always been guided by the Russian proverb, “Trust, but Verify.”
The foundation of the LCP credit process is the importance of collateral — mortgage or leasehold interests — in our investments. Debt service reserve funds, rate covenants and fully amortizing loans may be common protections in municipal finance, but across fixed income asset classes, collateral remains the ultimate source of lender protection in the event of financial stress or distress.
Strict adherence to this principle has led to our intensive focus on revenue bond issuers across eight primary municipal market sub-sectors. These are generally operating businesses serving their local communities with a high degree of essentiality. In many cases, mortgage collateral has proven critical for investor recovery when borrowers encounter unforeseen financial stress.
In our May Note, we highlighted a senior living credit that struggled to recover post-COVID. Working with creditors, the borrower executed a sequenced disposition of facilities that led to full redemption of bonds at par ($100), substantially higher than previous pricing levels near $55.
What we did not discuss was an earlier chapter of the story.
When the credit first faced financial stress, the borrower and its investment banker approached bondholders with a familiar proposal: Reduce debt and debt service by having lenders accept losses. In the municipal market, this is often presented as the only path to “right the ship”.
In this instance, however, bondholders took comfort in the strength of the mortgage collateral and encouraged the borrower to pursue a different solution. The eventual result was the sale of the facilities, the transfer of operational control, and most importantly, a 100% recovery for bondholders. Without the mortgage interest, bondholders would have been negotiating from a far weaker position.
The credit process created at our founding 16 years ago, and refined year after year by the credit team, remains the bedrock of our investment strategy. By adhering to our principles, focusing on specific sub-sectors and resisting the temptation to chase attractive yields, we have built a disciplined framework for portfolio construction and on-going surveillance that has served our investors well.
While we are proud of our default record, we are even more pleased with our cumulative credit loss experience. We are confident our process will serve both our clients and our firm well for many years to come.
We thank our clients and partners, many of whom have been with us since June 2010 for their trust and confidence. After a prolonged period of historically low interest rates, we look forward to the future with a strong foundation and interest rate environment that once again rewards investors with compelling yields.
Here’s to the next 16+ years…
The chart above shows the increase in value of $1,000,000 invested in the LCP composite at inception (net of management fees and expenses) vs. the benchmark, the Bloomberg High Yield Muni (LMHYTR) as well as the Bloomberg Muni (LMBITR) indices (it is not possible to invest in either Bloomberg Index). Please contact us with questions regarding credit profile, returns, taxable equivalent yields or further portfolio information. Past performance is not indicative of future results.