Talk Your Book: Investing in High Yield Munis

0:00Today's Animal Spirits Talk Your Book is brought to you by Nuveen. Go to Nuveen.com to learn more about the Nuveen enhanced high yield municipal bond fund. That's ticker NMSSX. We'll talk about it on the show today. That's Nuvine.com to learn more.

0:37Wealth Management may maintain positions in the securities discussed in this podcast.

0:44Welcome to Animal Spirits with Michael and Ben. Michael, one of the themes on our Talk Your Book segments that I've come to realize is that there are more corners of the market, especially in the credit space, than I think most people realize. There's a lot of different ways to finance projects, businesses, investments than you realize. And this is one of those spaces. So Nuveen has this high-yield muni bond fund. And it's an interval fund because these are relatively illiquid securities. But it makes sense in their muni bonds that fund these projects. These projects are sort of uncertain. So that's what makes them – these bonds don't trade very much.

1:29But there's just so many corners of the credit market that I think a lot of people don't even realize exist. That's right, Ben. So this is one of those conversations where a lot of new things for Ben and I, a lot we didn't know. So I hope you enjoy our conversation with Steve Lavin from Nuveen.

1:48Steve, welcome to Animal Spirits. Thank you very much. It's a pleasure to be here. Okay, so you are a high-yield municipal bond manager. And I have a question just about municipalities in the whole. and then we can kind of drill down into the strategy. But you obviously remember the Meredith Whitney prediction that all these municipalities were going to go bankrupt back in the 2010s, and it was a big story, and it got people all worried. My understanding is, because of all the fiscal support sent out during the pandemic, that a lot of municipalities are in much better shape than they were back then because of this.

2:18Is that a true reading of the situation? Yeah, it's true, and then there's more to the story. In hindsight, a lot of that stimulus was unnecessary because the expected massive contractions in tax revenue collections didn't occur. Actually, the contrary happened. We had huge increases in sales tax revenues, while income revenues and property tax revenues continued to grow on top of that. The story in the market this year, and to a lesser extent every year, but certainly this here is the deficit and its impact on treasury issuance and rates are moving higher with that. I'm curious to learn more about the municipal bond market.

3:03How are cities compared to the federal government? Like, are they funded? Are they running severe deficits? What does that look like? Yeah. You know, the big difference between state and local governments versus the federal government is that they cannot deficit finance themselves, right? They have to balance their budgets. And so you don't see large surges of municipal bond issuance just because there are growing budget deficits. I mean, that just doesn't happen. I mean, they can run deficits, but then they have to balance that with rainy day funds or increase revenues on the other side eventually, right?

3:41They just cannot grow and grow and grow because they can't print their own money. And so while the municipal bond market is positively correlated to Treasury yields, there are a lot of other technical factors that impact municipal bond yields. Such as? Primarily fund flows and issuance. So for example, this year, we are seeing a continuation of record issuance. So therefore, in the first quarter of 2025, the municipal bond market was the worst performing fixed income asset class, even over and above what was happening to the treasury yield pressure. And that was because of a huge surge of supply.

4:22Why is there so much supply given where rates are? Is that just because, I mean, obviously they would prefer to not issue new paper at these levels, but I'm guessing they have no choice in the matter? Yeah, there is somewhat of a no choice in the matter effect here because a lot of this is project financing. And projects just cost more. If you just consider the cumulative run-up in inflation, since inflation started to increase coming out of COVID, it just costs more to build. And so you think about just the cumulative run-up in CPI is a little bit more than 25%. And a 25 % increase in supply is not surprising under that context.

5:04But then there are other factors, policy factors. And so even the rhetoric or the rumors of possibly limiting or eliminating the tax exemption has pulled a lot of supply forward. And there's also fears that rates might continue to rise further in the future from treasury pressure. And so a lot of dealers and bankers are encouraging their issuers to get to market sooner. So there's just this pull forward and a lot of supply. Obviously, that will balance itself out as we get into the later stage of the year. But at this point, we are running at another record pace of issuance, even over and above last year, which was a record number of issuance.

5:47Michael is more of a gambler than me. So he likes to speak in odds a lot of times. So if you had to put that idea of they're going to do away with tax-exempt status of municipals, my thinking would be that's a very low probability event. You'd have to give me a plus 1 ,000 or something on that to make that worth the bet. Is that a pretty low probability outcome for you as well? Yeah, and the odds just fell considerably. I mean, the odds were already very, very low, and the odds fell considerably when the first draft of the big, beautiful bill came forward. There is no mention of that. It was just the idea that in the past, when we're talking about covering large deficits in a new tax bill, oftentimes they do throw the muni exemption in there as a starting point.

6:30And then it's been taken out. But in this case, it wasn't even in there to start. So high yield municipal bonds, what are we looking at? What does that opportunity set look like? What sort of coverage ratios? Well, I guess you said these are fully funded, but what makes something high yield? Is this like sketchy neighborhoods or what exactly? Yeah. I mean, that's the misconception often held is that when you say high yield municipal, you think of a sketchy, blown investment grade local government, right? But what we are really talking about are infrastructure project revenue bonds and what we really should be calling them are US infrastructure bonds.

7:15That's a much better brand. You should do that. Right, totally. We love that word. It's infrastructure. It's U.S. And the ironic thing here is that with all this talk about tariffs and repatriating manufacturing and industry, fundamentally speaking, high-yield municipals, which funds the majority of our nation's infrastructure, should be a large beneficiary. But yet, we're seeing that tariff volatility spill over into our market from a technical standpoint. So going back to the main theme here, high-yield municipal bonds are project revenue bonds. They have some common features to them. One, they typically are financing the construction and then the operation of a new infrastructure project.

8:00And they vary across a lot of sectors, healthcare, education, utilities, transportation, land development, individual site project development. And then they should, under best underwriting practices, be secured by the underlying collateral, the physical project itself, the land, the property, the building, etc. And then the bonds are secured by a dedicated revenue stream associated with that specific project. Now, sometimes these projects can have the backing of a state and local government kind of as a security backstop. stop. But your ultimate risk here is in the construction of the project.

8:39Will it be built on time and as designed, no cost overruns? Will it be turned on? So you have to go through a ramp up period. And then is it going to be used over the life of the bonds? So you have construction risk, ramp up risk, and operational risk. But as you resolve those three phases of risks, then you can progress a high yield below investment grade bond closer to that investment grade category. And then the bonds are typically called most successful high yield mini bonds do not last until their stated maturities. Oftentimes they are called because of the success of building it, turning it on and operating it.

9:18So what is the feature that makes these high yield or below investment grade? Like what is the reason for it? Is it just because of the nature of these projects that they're uncertain? Yeah, at start, they're speculative. So at the very beginning, oftentimes, what you're dealing with is a plot of dirt, right? So you issue the bonds to build the infrastructure piece. And so it is speculative. There is no certainty that the project can be built. There is no certainty that it will ramp up. And there's no certainty that there will be utilization to service the bonds. But as the project progresses in its life cycle, those risks, get either partially or fully resolved.

9:57I'm looking at your website and there's a lot of... I like what you're doing here. I like what you're doing here. You've got the maturity breakdown. You've got top states and territories, sector allocation, credit quality. Credit to you guys. Very well done on the visuals here. Thank you. What stands out to me, and there's a few things, but I'll start with this. Almost 84 % of the portfolio as of the end of April, 2025, are not rated. What does a not rated municipal bond look like? Why are they not rated? I don't know. This is a bit foreign to me. Yeah. And it oftentimes appears that way to folks that aren't inside the baseball game.

10:36And the reality is, is that - Oh, I'm in the game. No, I'm just kidding. Go on in. The water's warm. Non-rated is the heart and soul of the high-earned market. The The reality is that the vast majority of the existing high-yield mini market is non-rated. If you look at the trailing last three years, over 80 % of all new issuance has come non-rated. It's just inherently what the market is. And so why, right? Well, most high-yield mini issuances are small to medium size. Obviously, there's the big blockbuster deals, the billion-dollar-plus deals. There's several of them throughout the year. But your typical high-yield mini bond issuance is going to fall into that$500 to$200 million range.

11:22It's going to be, as I said, speculative in nature. So it doesn't have a chance to get an investment grade anyway. And you're selling to institutions. You're not selling high-yield mini bonds to retail that need the public coverage. They need the public rating. They need someone to do research for them. Institutions should be doing their own independent research. And so why pay for a rating? Why? And so a lot of issuers just don't choose to go out and say, oh, well, I'm going to pay a fixed amount of costs. It's going to drive up my borrowing costs, and I'm going to get a B - rating anyway. Is there a size component where it's over a certain dollar amount or I guess under a certain dollar amount that just doesn't make sense because it would be prohibitively expensive?

12:02Yeah. I mean, it's obviously the discretion of the issuer, but there's a fixed amount cost to getting a rating. Usually it's several hundred thousand dollars. And so, you know, why pay that when all it's going to do is, you know, lower the economies, right, and your project? You know, even large issuers oftentimes do come non-rated because they're too complicated. That's the other part of the reason why there are non-rated bonds is that you got to fit inside a box for a public rating agency. You have to fit inside a methodology. And I'll use World Trade Center for an example, because everyone knows that project, right?

12:42Municipal bonds financed the construction and the lease-up period of World Trade Center number three. And it did not get a rating from the rating agencies because at that time, the bonds were issued, there was construction risk and lease-up risk. And the rating agencies had a model for either or, not both. They didn't have a hybrid model. And so therefore it was non-rated. And so oftentimes these, these structures are just too complicated and they don't fit inside the established methodologies. So what kind of spread are we looking at here in high yields? Like, or what type of spread are you looking for in your portfolio over other, you know, higher rated munis or the tenure, I guess?

13:17Yeah. I mean, the average high yield muni spreads are just inside 200 basis points right now. And to someone who has more experience in the high yield corporate market, you're like, oh, that's really tight. Well, high yield. I was going to say that doesn't seem like a lot of juice. Yeah, right. It's not compared to the high yield corporate market. And the reason there's a lot of reasons why, but the basic explanation is that there's not as much risk. If you just look at default risk, historically, high yield munis default substantially less than high yield corporates. I mean, Moody's has the longest historical default study out there.

13:50They look at everything they've rated going back to 1970. And if you just kind of take the midpoint, right, That double B category of high yield. High yield municipals have an average 10-year cumulative default rate that's about 20 % of the same rated high yield corporates. And then on top of that, the recovery values are substantially higher within that category. So there's just less risk. And there's better collateral involved. So at 200 basis points, that's kind of around the historical midpoint. Now, you can get higher, like when you look at COVID, for example, or if you look at the summer of 2013, both of these periods when you have a lot of big outflows and cause spreads to blow out, you can get 300, 350 basis points.

14:36That's usually where it caps off, is in that mid 300 basis points. Because at that level, you're starting to talk about tax equivalent yields that are now going to start competing with high-yield corporates. So that other piece of it is that tax exemption kind of keeps a ceiling on how high spreads can get in our space. It can get a lot tighter. So the historical tights, if you go back to like the early 2000s, you go to the credit bonanza of 2007, or even if you get into like the summer of 2016 when things were really tight, you can get around plus 100 basis points on average. So we're kind of in that midpoint right now.

15:17And I would argue that spread should be a lot tighter just given the strength of high-yield mini credit currently. I'm looking at the top states and territories. And Colorado is number one as of the end of April 2025. It was 18%. What's going on there? Weed farm infrastructure? Yeah. Well, look, I mean, the top states, right? Colorado, Florida, Texas, right? Are right up there. And Wisconsin. And so Wisconsin, let's put that aside for a second. Okay, we'll hold Wisconsin aside. That's very misleading, but we'll explain it. But the three states to pick on right now are Colorado, Texas, and Florida.

15:57So what do those three states have in common? Population growth, demand for infrastructure. And so that explains that. We don't have a top-down view. We say, oh, let's go buy a bunch of projects in those states. Those overweights are a byproduct of cumulative credit selection opportunities. Because we're finding more infrastructure demand and more infrastructure development in those particular states. And so what are they, right? Well, it's land and community development. It's education, primarily charter schools. Charter schools are very necessary when you have strong population growth, strong home formation, because it puts a lot of pressure on the public school system.

16:39And charter schools play a very important release valve in those dynamics. And then also transportation and health care. So when you take those four sectors, that explains the vast majority of those overweights. So because a lot of these bonds are not rated, is that one of these things where it's an overlooked sector? Maybe this is a softball question for you, but it seems like a lot of, I'm guessing a lot of family offices or certain investors maybe have guidelines where they can't own non-rated bonds. Does that make it easier for you as an investor to pick through the winners and losers? Yeah, a lot of independents do have those restrictions.

17:14I mean, for example, I mean, we have some institutional accounts where there are restrictions just like that, right? They want to see and have transparency in what they own. So, therefore, the non-rated space is naturally inefficient, right? Everyone's going to have a difference in opinion on what a credit rating should be and why. And therefore, there should be differences in opinion on what that bond is worth, what the spread should be worth, what the yield should be worth, you know, price, obviously. And so to operate effectively in this space, you have to be able to do your own research. Independent research is critical.

17:53We have 25 dedicated municipal bond research analysts. The average years of experience is 20 years. They're all sector specialists. They will follow these issuers for their entire career. They get to know them better than the operators. For example, we have some hospital analysts that have followed credits and they have seen, you know, CFOs come and go over and over and over and they just know the hospital better than they do. Right. It's all about independent research. And even within the peer group, you see huge variations in terms of the size and the dedication and the experience of research staff, even within the high yield meaning fund manager space.

18:36How long do these projects take to complete? Because I'm looking at the maturity breakdown and it's a lot of years. Yeah, it is. It is a lot of years. These are long-dated assets. And so it's long-dated debt, right? So you just think about the asset liability matching that's required, right? These are long-dated assets. The bonds are designed to be paid by these revenue streams that can be stretched out of the useful life of the project. But as I said earlier, the reality is that bonds don't usually last until their stated maturity. Most high yield mini bonds have features like sinking funds, mandatory turbo redemptions, and call options.

19:18So does the duration of your fund end up being a lot lower than the maturity profile then? Yes. Yes. So if you look at a high yield mini bond, it's pretty typical. If they have an average maturity of 20 years, the duration is going to be closer to 10, 12. There's just a lot of optionality. So option adjusted statistics are very important. You think about high yield meaning, you think credit. There's a lot of quant that goes into high yield meaning bonds. There's just so many structural features in high yield meaning bonds that make valuation opportunities even more prevalent in our space. So it's not just about credit.

19:53Sorry, I'm sorry to cut you off. And these municipalities obviously want to pay them off earlier. Yes. So they want the optionality. because if they can build it and they can ramp it up and they can show that, hey, look, everyone's coming to our project. We're using it. We're getting debt service coverages of two plus times. Then you can go to a rating agency and plead your case and say, give me an investment grade rating. Then you get your investment grade rating. You come to market, call your bonds, and you refund. There's a lot of refunding opportunities in high-level media markets. So there's a lot of negotiation that should go on.

20:26Not everyone has that type of pricing power, but when you do, you want to use it and make sure that not all the optionality is in the favor of the issuer. You want to wrestle some of that back and engineer some of your own positive convexity. So when we look at a high yield mini bond, we want to buy it at a discount on new issue, and we want to make sure that the call features take us out at a premium. And so you typically buy something kind of in the mid to high 90s, and you're typically taken out somewhere in the low to mid-10s. So like 103, 105 call is pretty common for the high-level money bonds that we buy.

21:01Why would a bond trade at a discount when it's offered? It's part of the negotiation. It's what bondholders - Just to attract investors? Yeah, exactly. It's part of that negotiated deal process. Ben, you don't know the power of being bald. If you look like Steve and you come with a big pile of cash, you've got favorable terms. That's right. There's a lot of pricing power that you've got to throw around. And it's not just about size. It's about expertise. So having a research analyst is very important because they're not just looking at the deals as printed. They are talking to the bankers and the issuers weeks, if not months before they come to market, kind of impressing upon them our best underwriting practices and saying, look, if you have these security features and this bond structure and this type of collateral package, these are the best practices for this particular sector.

21:55You're going to increase the likelihood you're going to have a successful deal and your underwriting risk goes down. The risk of the underwriters, they do it themselves. They come to market, no one shows up and they promise their issuer, hey, we're going to get this deal done. Well, I'm going to take down all these bonds and now I got to go sell them in the secondary market. So they want to know that they're going to have a successful deal. So there's negotiations for deal structures really, really important in this space. How much, I assume that these bonds that you're buying are being held to maturity.

22:26Obviously, some of them are being called away. So what does the turnover end up looking like in this fund? Yeah, there isn't a lot of turnover from our perspective, right? We are, you know, first and foremost, long-term fundamental investors, right? But that doesn't mean we hold everything to maturity. There's still a lot of relative value opportunity in the secondary markets. So the turnover is typically driven by two things. Relative value swapping, right? When swapping the inefficiencies in the market, selling something that we view too rich, buying something we see too cheap, right? I've obviously oversimplified it, but that's basically it.

23:00And then there's a lot of tax efficiency management. So turnover can also be driven by what we call yield harvesting, where you're harvesting tax losses and rebooking at higher embedded yields for the portfolio that then can support the number one goal in a high-yield unit product, which is to maximize the level of tax-exempt income. I'm not going to lie. We've had clients in the past where it's hard to get them because it's essentially phantom income, right? That the tax savings are phantom income. So sometimes we have to show them the actual tax equivalent yield to make it make sense, right?

23:35Right. And we love to do that. It's eye-popping when you're in an environment like today. The average yield of the Barclays Bloomberg High Yield Media Index right now is around a 580. Obviously, active managers should be doing a lot more. Products like an interval fund can do that because they're better set up to take advantage of yield opportunities. But yes, you're pushing high single digits in terms of the taxable equivalent yield, and that's going to beat anything in the high-yield corporate market that's talking about a performing bond. And that's before you would even risk adjust it. Again, let's go back to our comments about the lower defaults and the higher recoveries.

24:14And with active management, you can really minimize that. Steve, for people that want to learn more about the fund, what type of structure is it? So it's called an interval fund. We did not invent the machine. We borrowed it, right? Interval funds have been out there for a while. But the whole concept of an interval fund is to provide interval liquidity. You can buy into it with daily subscriptions. It trades with a ticker, right? It has a daily NAV strike. It pays a monthly dividend. So from that standpoint, it looks and talks just like a mutual fund. But you don't have access to daily liquidity.

24:52And this really gets down to the whole philosophical concept of the product, taking advantage of the expanding illiquidity premium in our market. And so it's not for everyone. Interval funds do not offer daily liquidity. And so the investor has to consider that trade-off, right? I don't want or need all of my high yield mini exposure to be daily liquid. So why am I using a daily liquid product where that liquidity profile, the need to offer daily liquidity is a constraint. So you give more of that illiquidity premium to us to deploy. That's the whole point. So the trade-off is that I will forego daily liquidity for quarterly liquidity.