Sector Commentary

December 13, 2017 by

July 25, 2017 by

Greg Bell, CFA
Director of Municipal Bonds

Surge in Tax-Exempt Performance Driven by Strong Technicals and Indifference to Tax-Reform Risks

The tax-exempt sector experienced very strong performance due to a continued build in positive technicals however; the market did absorb some rate volatility to close the quarter. Hawkish commentary from the European and British Central Banks pressured 10 year Treasury yields higher by 17 basis points (bps) over the last three trading days of the quarter. Muni yields in 10 years followed suit, with a selloff of 14 bps yet even with this backslide, the sector saw substantial gains for the quarter.

Very strong demand flows combined with a manageable new issue calendar provided the basis for the firm tone in the market. Municipal yields in 10 years finished the quarter by contracting by 26 bps, while 10 year Treasuries yields fell by a total of only 8 bps. The outperformance by the muni sector drove relative valuations to very expensive levels with 10 year municipal-to-Treasury yield ratios finishing the quarter at 86%.

In reviewing the primary catalysts for the strong muni performance, a very manageable calendar continues to play an important role. Overall issuance this year is down from last year by 14% driven in large part by a sharp contraction in refinancings. This segment of the new issue calendar produced a record last year and with rates surging at the end of 2016 the market expected to see a reduction in this issuance during 2017. Year-to-date the flow of deals classified as straight or pure refinancing saw a drop of 46% compared to 2016. However, we could be in the midst of a dramatic turnaround in this trend. Since the beginning of the year, tax-exempt yields in 10 and 20-year bonds have dropped by 32 and 25 bps respectively. As a result, the interest cost savings available from refinancings have become more compelling and are in line with the savings levels that were available over the last two record-producing years. The market is already showing signs of taking advantage of the new savings opportunities, with the monthly average of straight refinancings over the last two months increasing by 54% versus the monthly average over the first four months of 2017. We expect that this issuance trend will continue to build over the balance of the year if rates fall or remain range-bound around current levels.

Even with a substantial increase in supply, the market is poised to maintain its expensive relative valuation profile versus Treasuries in the near term. The market is currently enjoying record reinvestment flows of coupons/calls/maturities that should be in place through the end of August. Additionally, investors have seemingly become indifferent to any risks related to potential tax reform. As of this writing, muni relative valuations to taxables have richened to the point that they now exceed the levels that existed before the presidential elections. It appears that the market consensus has “priced-out” the risks for tax reform in 2017 driven in part by the protracted execution of the repeal and replacement of the Affordable Care Act. Although recent efforts have failed, congress and the President could remain preoccupied with this agenda item and hinder their efforts toward advancing other priorities. Consequently, it appears that expectations for tax-reform have been pushed into 2018 or beyond and as a result muni investors have become more emboldened to take more duration risk. That’s evident by a sharp 30 bps flattening in the muni yield curve from two to 30 years during the second quarter. As long as the execution of the President’s political agenda on healthcare and tax-reform continues to be protracted, investors will likely remain indifferent and demand flows should remain unabated.

In looking forward to our outlook for the third quarter and the balance of the year, we believe that the market is at overbought levels. Positive technicals should support the market over the next two to three months, but the market could see these supply/demand imbalance factors weaken going into the fourth quarter. The current yield environment increases the likelihood that a building supply cycle could develop on the heels of compelling refinancing metrics, which could pressure relative valuations to weaker levels. Additionally, we believe that the risk related to tax-reform, especially a reduction in corporate tax rates, is still an important event that bears close watching. Should there be any positive developments toward this agenda item as the Republican Party becomes more driven to produce reform and cuts before the 2018 mid-term elections, we could see a substantial amount of rate volatility and weaker relative valuation levels. Given these risks and the sector’s expensive relative valuation profile, we have moved to an underweight bias for the sector.

Disclaimer: Asset Allocation & Management Company, LLC (AAM) is an investment adviser registered with the Securities and Exchange Commission, specializing in fixed-income asset management services for insurance companies. Registration does not imply a certain level of skill or training. This information was developed using publicly available information, internally developed data and outside sources believed to be reliable. While all reasonable care has been taken to ensure that the facts stated and the opinions given are accurate, complete and reasonable, liability is expressly disclaimed by AAM and any affiliates (collectively known as “AAM”), and their representative officers and employees. This report has been prepared for informational purposes only and does not purport to represent a complete analysis of any security, company or industry discussed. Any opinions and/or recommendations expressed are subject to change without notice and should be considered only as part of a diversified portfolio. A complete list of investment recommendations made during the past year is available upon request. Past performance is not an indication of future returns. This information is distributed to recipients including AAM, any of which may have acted on the basis of the information, or may have an ownership interest in securities to which the information relates. It may also be distributed to clients of AAM, as well as to other recipients with whom no such client relationship exists. Providing this information does not, in and of itself, constitute a recommendation by AAM, nor does it imply that the purchase or sale of any security is suitable for the recipient. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, inflation, liquidity, valuation, volatility, prepayment and extension. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

July 24, 2017 by

By Elizabeth Henderson, CFA
Director of Corporate Credit

Market summary and outlook

The Investment Grade (IG) Corporate bond market delivered a 3% total return in the second quarter 2017, with spreads tightening 9 basis points (bps). Risk assets performed similarly, as the S&P Index returned 3% in the second quarter, high yield 2%, and Emerging Markets 2% as well. Corporate bonds with maturities greater than 10 years outperformed shorter dated securities, contributing more than two-thirds of the total return performance of the IG Index per Bloomberg Barclays. Similarly, BBB rated securities outperformed and drove more than 50% of the performance.

We continue to see strong demand from bond funds for investment grade securities, and foreign buying of USD IG debt remains a source of demand despite the less attractive yield advantage (net of hedging costs). New issue supply normalized in the second quarter, and the relatively light new issuance in longer dated maturities was one contributor to the outperformance of long corporate bonds. The unwind of QE may be a headwind for spreads in the intermediate term, but the market has digested the information constructively thus far.

We expect returns to be generated largely from income over the near term, as the potential for spread tightening remains limited unless growth surprises to the upside and/or companies begin to meaningfully reduce debt. Despite lackluster valuations, we have a neutral opinion on the IG corporate sector, expecting technicals to remain supportive and fundamentals relatively stable over the near term given policy related uncertainty, improving overseas growth, and favorable lending conditions. Margin pressures such as rising labor costs and/or disappointing growth remain a risk given the elevated level of debt leverage and size of the credit market, BBB rated securities specifically. Tactically, we are maintaining flexibility to add on spread widening related to the unwind of central bank quantitative easing (QE).

Source: Bloomberg Barclays, AAM

Performance summary year-to-date

Spreads continued to tighten in the second quarter, with OAS 14 bps tighter year-to-date. Energy spreads underperformed in the second quarter due to the heightened volatility of oil prices. Year-to-date, every corporate sector has generated positive returns, with the Basic Materials and Finance sectors outperforming.

Rating actions have been positive with more than two times the number of “rising stars” (bonds moving from High Yield to Investment Grade) vs. “fallen angels” (from IG to HY). Improving fundamentals was the driver of 78% of the upgrades, with M&A being a smaller contributor. The same held true for the downgrades. M&A activity has remained active this year for larger deals. M&A related leverage loan volumes were down in the first half. LBO related activity has stalled due to high valuations and the limitation on leverage by the Federal government, although more leverage is being used to fund deals this year vs. prior years. Net demand for leveraged loans has been strong, resulting in weak covenant protection. We continue to monitor loan market fundamentals for signs of stress.

Source: Bloomberg Barclays Index (as of 6/30/2017), AAM

Credit fundamentals

Credit metrics remained fairly stable in the first quarter of 2017. We expect continued revenue and EBITDA growth in the second quarter, although it’s likely to moderate vs. the first quarter. Sectors expected to drive growth include Technology, Materials, and Energy with Telecom expected to be a drag. While it is early in the financial reporting season, we are pleased at the rate of loan growth for large, diversified banks given the weakness witnessed in the first quarter. Moreover, small business lending conditions as reported in the Credit Managers Index have improved, and the high yield and leverage loan markets remain accommodative. That said, we are not seeing signs of a break-out in growth that would cause U.S. GDP forecasts to be revised materially higher.

Policy uncertainty remains high, with tax reform unlikely in 2017. Sectors that were expected to benefit from firms repatriating cash from overseas have continued to access the debt market to fund acquisitions and debt maturities. A survey by Bank of America (Shin, John; “2017 Risk Management Survey” 7/10/2017) asked companies how they plan to use repatriated earnings, and of those that expect to benefit, 65% would use earnings to reduce debt as well as other uses such as share repurchases (46%), M&A (42%) and capital expenditures (35%).

Interestingly, the companies that have been the most aggressive buyers of their common stock have seen their stocks lag in performance relative to the broad market (S&P 500). Since the financial crisis, this has not occurred on an annual basis except in 2014. We view that constructively from a credit perspective since firms have been using debt to fund share repurchase programs.

Margins remain historically high for many sectors, with management increasingly communicating labor cost related pressures. This remains a concern of ours especially as we saw the JOLTS Quits rate for the private sector increase to a level not seen since 2006. This has been a reliable indicator in the past for predicting increasing labor costs. Sectors like Consumer Discretionary and Healthcare are particularly exposed to rising labor costs. We have been very selective within these sectors, monitoring ROE and projected revenue growth. Sectors that are more immune to rising wages include Energy, Technology, and Insurance.

Source: Factset, AAM as of 3/31/2017 (Data excludes Energy, Metals/Mining, Financials, Utilities)

QE unwind

This Fall, the market expects the ECB to announce plans to taper its bond buying program and the Fed to announce that it has begun to shrink its balance sheet. If bond buying is reduced by half, what will happen to the demand for IG fixed income? While there has been a correlation between central bank purchases and the direction of US IG credit spreads, the cause of this relationship is less certain.

Since the financial crisis, there has been less net spread product issued due mainly to the contraction in the Structured Product and Muni markets. If we see MBS spread widening related to the unwind, it could put pressure on the Corporate market. However, we believe spread widening risk is higher for MBS since the net supply related to the unwind would be material as a percentage of the total MBS net supply expected in 2017 (>50%) vs. a much larger net supply of IG Corporates (<20%)** (footnote JPM Eric Beinstein June 2017; US High Grade Credit Market Trends and Outlook)

We acknowledge this technical risk, and given lackluster valuations, maintain flexibility to add on spread widening.

Source: National central banks, Citi Research, EMFX reserve changes are FX-adjusted

Written by:

Elizabeth Henderson, CFA

May 8, 2017 by

**Chris Priebe**
**Structured Products Strategy and Trading**

Subprime Auto ABS has been a prominent headline recently with multiple articles suggesting that increased delinquencies are a sign of a bubble getting ready to burst, similar to the mortgage crisis of several years ago. So AAM took a look behind the headlines.

What does a Subprime Borrower Look Like?

Obviously, a borrower who falls into the subprime category is someone who is considered a higher-than-normal risk. Very often individuals find themselves in the subprime category due to one significant occurrence or due to a series of unfortunate events. Bad investments, a failed business, debilitating student loans, loss of employment, catastrophic medical bills and many other circumstances can quickly force people into precarious financial situations.

So what is the profile of a subprime borrower? They may have a history of late or missed payments, default debt, excessive debt, and personal bankruptcy or have few or no assets. As a result, they can only qualify for higher interest rate consumer debt and consequently, pay more in interest for mortgages, credit cards, car loans and car leases. In the United States subprime borrowers are typically categorized as individuals with FICO scores of below 640.

In 2008, subprime lending to people who may not otherwise have qualified lead to the mortgage crisis. Per JP Morgan, roughly 70%-80% of subprime borrowers were issued adjustable rate mortgages and when those loans adjusted to higher interest rates, refinancing was difficult due to declining home values. This resulted in a widespread domino crisis beginning with mortgage defaults which lead to foreclosures and eventually resulted in the declining value of mortgage-backed securities and a meltdown of the entire system.

Is that same trend happening today in Auto ABS?

In AAM’s review of data and information from multiple sources, the good news is that a mortgage-like meltdown does not seem imminent in the Auto ABS sector. According to JP Morgan:

Subprime and deep subprime loans are a relatively small portion of new sales;
Delinquency increases have been modest outside of subprime;
Loan duration has seen no recent inflection;
Premiums to US Treasuries that auto finance companies must pay have moderated.

JP Morgan goes on to state:

“Auto ABS collateral performance shows signs of deterioration in aggregate with the belief based on history that there will likely be a shakeout and/or consolidation of lenders. However, the feeling is that Auto ABS structures remain sound in spite of potentially higher losses.”

According to Deutsche Bank, the number of cars registered per household is as high as ever at 2.25 and most auto loans are issued to super-prime borrowers. Also, per JP Morgan, new car loan FICO scores remain flat at 711 going back to 2015, and while delinquencies have risen, they have not done so sharply. Although loan durations reached an average of 68 months in 2016 this increase is the result of longer average length of ownership and vehicle durability. It appears that it is well qualified buyers who are driving up loan durations due to continuously increasing new car prices.

So Why the Headlines?

The reason for the worrisome headlines is because subprime Auto ABS cumulative net losses appear to continue to climb. According to Merrill Lynch, cumulative net losses for the 2014-2015 vintages are higher than the 2011-2013 vintages for sub prime issuers in aggregate. And, the 2015 vintage is tracking higher than those for the 2007 vintage.

Non-prime auto loan ABS – Cumulative Net Losses

Source: Intex, BofA Merrill Lynch Global Research

However, it must be noted that in comparing 2007 vintages to 2015 vintages, the latter includes additional and new lenders who focus on the deep subprime market, thereby skewing the results. When the data is normalized to compare similar types of lenders between periods, the 2015 vintage performs much better than 2007. According to Merrill Lynch, “Specifically, at 15 months of seasoning, the 2015 vintage has CNL of 4.3% while the 2007 vintage has CNL of 8.4%. Unadjusted, the CNL would be 6.6% for the 2015 vintage and 6.2% for the 2007 vintage.” So, as JP Morgan states, the sky is not falling on the automotive finance industry.

Non-prime Auto Loan ABS – Cumulative Net Losses – Normalized
2007 v. 2015

Source: Intex, BofA Merrill Lynch Global Research

But there are some negative trends that warrant attention in the future, including:

Car dealer inventories are rising as more vehicles come off leases;
Lease penetration has risen to new highs as consumers search for ways to offset higher new vehicle prices;
Even more vehicles will come off lease in the next three years;
Overall auto loan delinquency rate has moved slightly higher due to uptick in subprime delinquencies

What Does This Mean for AAM Clients?

At AAM, we believe that subprime auto loan performance will continue to deteriorate in 2017 and 2018, although at a slow rate. Similar to earlier cycles, credit expansion in deep subprime auto lending is moving credit performance to weaker levels. The make up of more recent subprime lenders accessing the ABS market has dramatically changed since the 2008 recession. Lender and product mix and weaker vehicle prices could drive losses higher. The current level of enhancement for most auto ABS should limit the downside risk for these subprime deals.

Auto headlines will continue to hit news wires. Used car supply has close to doubled since 2011 and 2012. Higher than usual lease sales will continue to put pressure on supply in the future considering that 30% of all sales are now leases, which is up from 20% a few years back. Close to four million cars annually will be coming off lease in 2017 thru 2019 up from two million annually just a few years ago. AAM structures and light exposure to benchmark subprime ABS autos is nominal and we look to use any widening as an opportunity to add to senior bonds.

At AAM, we still view benchmark ABS issuers in prime auto loans, high quality credit cards, rate reduction, rail car and equipment ABS as a safe haven in structured products. The auto market is seeing tiering in the weaker and new sponsor names but we don’t see a systematic subprime auto breakdown ahead. The market will see spread separation in the usual benchmark subprime issuers versus the deep subprime entrants the market has recently seen.

Despite the subprime credit deterioration news, economic expansion and respectable wage growth is supportive for a majority of the ABS market. While we do see worse credit performance ahead in the student loan market place, consumer lending and deep subprime auto, we believe ABS investors will be well protected by their structures and credit support.

April 20, 2017 by

By Elizabeth Henderson, CFA
Director of Corporate Credit

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Market Summary and Outlook

The Investment Grade (IG) Corporate bond market delivered a 1% total return in the first quarter 2017, with spreads tightening 5 basis points (bps) since year-end 2016. Risk assets outperformed, as the S&P Index increased close to 6% in the first quarter, high yield returned approximately 3%, and Emerging Markets also returned approximately 3%. After outperforming in the fourth quarter 2016, corporate bonds with maturities greater than ten years underperformed in the first quarter.

We continued to see strong demand from bond funds for investment grade securities despite volatility in high yield fund flows. Foreign buying of IG debt has fallen from the very strong levels in 2015-2016, but we continue to expect it to remain a source of demand given the yield advantage (net of hedging costs) of U.S. IG bonds. New issue supply was higher than expected to start the year, with companies accessing the market in anticipation of higher rates, a modest headwind for spreads.

The Option-Adjusted Spread (OAS) is approaching our target for the year; therefore, we expect returns to be generated largely from income over the near term. Our base case expects stable to improving commodity prices, approximately 2% domestic economic growth, containment of risks overseas, regulatory relief in the U.S., and some tax relief. If risks to our base case increase to the downside, we would expect spreads to widen as Treasury yields fall. However, we believe the risk of material spread widening due to an increase in default risk is low given the availability of credit and low probability of a recession. Uncertainty should keep event (and ratings) risk more subdued as well.

Source: Bloomberg Barclays, AAM

Performance Summary and Year-to-Date

The driver of returns for Investment Grade Corporates in the first quarter 2017 was primarily coupon income with spreads starting the year at relatively low levels. Performance has been driven primarily by the higher yielding sectors, Energy and Basic Materials, as well as Financials that tightened due to the prospect of higher interest rates and regulatory relief. For Metals and Mining, metals prices stabilized due to supply disruptions caused by weather and political issues and solid Chinese economic data. This coupled with credit rating upgrades drove tighter spreads for Metals and Mining issuers. The risk of debt funded acquisitions caused the Telecom/Media/Technology sector to underperform even though it is one of the wider spread sectors.

Source: Bloomberg Barclays Index (as of 3/31/2017), AAM

Credit Fundamentals Expected to Improve From Cyclically Weak Levels

Credit metrics continued to weaken in 2016, as EBITDA growth did not keep up with rising debt levels, resulting in debt leverage to increase once again. That said, companies became more parsimonious with debt leverage in the second half of 2016 in response to the capital markets closing and spreads widening meaningfully with a rising probability of a recession earlier in 2016.

We project improving revenue and EBITDA growth in 2017 driven mainly by:
Higher commodity prices, benefitting energy and basic material issuers
Higher interest rates relative to 2016 and modest loan growth, benefitting banks
Improving emerging market economies, consumer demand for PCs and smartphones (iPhone 8, new features), and investment in cloud infrastructure, benefitting technology issuers.

Optimism remains elevated post the election, and analyst estimates for EBITDA and capital spending for the majority of sectors remains higher as well. Entering 2017, our outlook for credit fundamentals was generally positive except for a handful of sectors where we expected growth to disappoint (e.g., Autos, Retail, Cable). Growth disappointments related to secular challenges or cyclical slowdowns keep event risk (and thus, ratings risk) elevated. For example, after a disappointing fourth quarter and forecast, S&P downgraded Under Armour from investment grade to high yield.

Default Risk Falls

We expect the default rate to fall in 2017 due to higher commmodity prices and a much improved credit market. Bank standards have loosened, yields have fallen (high yield, investment grade and emerging markets), and the leveraged loan market is wide open after being closed for a period of time in 2015-2016. Demand is especially strong for leveraged loans, causing spreads to tighten in CLOs and bank loans. This has resulted in loan refinancings and investor willingness to accept looser covenants (“covenant lite”). Lastly, the Credit Manager Index continues to reflect a favborable environment for non-bank lenders.

The credit cycle, which had appeared to have peaked in late 2015, has been rejuvenated. Until we see evidence of credit contraction, we expect spreads to remain range bound (OAS between 110 – 140 bps).

Rating Stability Expected

The credit rating of the IG Corporate market has fallen over the last ten years as the percentage of BBB rated securities has increased due primarily to: (1) rating downgrades as companies take advantage of lower rates to increase shareholder returns (share repurchase, M&A), (2) changes in rating methodologies in the Finance sector post the financial crisis, and (3) an increase in the number of non-Financial issuers, which tend to be capitalized with more debt.

Source: Bloomberg Barclays (based on market values); AAM

Tax policy is uncertain, and the changes being discussed have varying consequences to IG issuers. While we have an understanding of how this may affect firms in various industries, we (and management teams) are at a standstil until there is more clarity on what is likely to pass. At this point, we do not expect meaningful changes to the tax code with a modest reduction in the corporate tax rate most likely. Except for industries that face structural issues such as Retail, we expect ratings to remain largely stable in this period of uncertainty despite a historically flat WACC curve by credit rating.

Market supply and demand technicals remain supportive

Insurance and Pension Funds, traditional holders of corporate bonds, increased purchases in 2016, on the prospect of increased rates and because competing asset classes were less attractive. Comparatively, money market funds sold corporate bonds due to money market reform. But, the real story was the increase in demand from foreign investors. Foreign ownership of corporate bonds has been rising over the past twenty years with an acceleration over the past couple years given very low (or negative) interest rates in overseas markets. Buying was especially strong from European investors, as the ECB included corporate bonds in its bond buying program, causing yields and supply to fall.

Source: Morgan Stanley

What do we expect this year from foreign buyers? We believe the political and geopolitical uncertainty in Europe will support an accomodative ECB and keep rates low over the near term. The risk is that the ECB becomes more hawkish due to higher than expected economic growth or inflation. We do not believe that risk is incorrectly priced today.

The other technical benefit to IG corporate bonds today is the relative attractiveness to fixed income asset classes such as Structured Products and Municipals, which have experienced spread tightening year-to-date. Moreover, with equity valuations rising and credit spreads tightening in risk sectors such as high yield and emerging markets, it increases the relative attractiveness of IG corporate bonds.

One risk over the near-to-intermediate term is related to balance sheet management by the Fed. Mutual Funds reduced their holdings of MBS after 2008 (per Fed Flow of Funds data), increasing their allocation to credit. If a Federal Reserve unwind of its QE program makes Treasuries and/or Mortgage Backed Securities (MBS) more attractive then a subsequent rotation out of credit and into MBS by fund managers would likely put pressure on corporate spreads.

Written by:

Elizabeth Henderson, CFA

April 20, 2017 by

Municipals Experienced Strengthening Technicals during the Quarter.

The tax-exempt sector experienced mixed performance during the first quarter overall, but stronger technicals were building by the end of the quarter. At the beginning of the year, municipal bond investors were concerned about both a rising rate environment and the prospects for major tax reform that could reduce the relative valuations for the sector. Those concerns resulted in very robust demand for short-dated maturities around the 5 year and shorter area that helped push yields lower by 27 and 24 basis points (bps) in 3 and 5 years, respectively. By contrast, the worries over the potential for a substantial cut to the corporate tax rate to 20% have generally been felt in the 15 to 30 year area of the yield curve. Insurance companies and banks, the investors that provide most of the sponsorship to that part of the yield curve, have been very cautious and have favored a neutral positioning until more clarity exists on the extent of tax reform. Yields in that range ended the quarter 1 to 3bps higher. The clear shift in reducing duration risk during the quarter resulted in the slope of the yield curve from 2 to 30 years steepening by 37 bps to a one-year high of 220bps on March 9th.

Since that time, the market did receive some unexpected support from positive developments related to supply technicals. March is historically one of the weakest technical periods of the year. New issuance typically spikes during the month as state and local governments finalize budgets and identify spending initiatives, along with refinancing opportunities. This building supply cycle typically outstrips demand, as reinvestment flows from coupons/calls/maturities fall to the lowest point of the year during March and April. However, this year, March supply came in well-below expectations at $29.8B, which was a drop of 30% from March 2016 and 20% below the 10 year average for March. The major catalyst for the drop has been the rise in interest rates. Municipal 10 year rates moved to a 2017 high of 2.49% during March, which was 78bps higher than average 10yr yields during 2016. The higher rate environment substantially reduced the universe of deals that could generate the necessary reduction in debt servicing costs to execute refinancings.

The market also benefited from the failure of congress to pass repeal and replacement of the Affordable Care Act. The lack of repeal of the law left intact the 3.8% Medicare surtax on investment income, which continues to make tax-exempts attractive relative to taxable alternatives subject to this tax. Additionally, the repeal and replace legislation would have generated a substantial reduction in the budget deficit and would have helped pave the way for a more aggressive push toward cutting corporate rates to the 20% level targeted by the House Speaker, Paul Ryan. Without the budget deficit savings, the market appears to now expect a corporate rate in the 27% to 30% range. Since March 15th, these developments resulted in 10 year muni yields falling by 24bps and the slope of the yield curve from 2 to 30 years to flatten by 17bps.

In looking at our outlook for the 2nd quarter, technicals should continue to exhibit a strengthening trend into the end of the quarter. Reinvestment flows are expected to be the highest of the year during June and July 1st, while supply is expected to remain manageable. However, if rates continue to move lower, cost savings from refinancings could become more compelling and we could see a renewed surge in supply levels. The market is also continuing to wait for more clarity on the extent of tax reform and the sector could experience some volatility around this issue. With our more constructive view on demand technicals, we are transitioning accounts from an underweight to a neutral bias.