With strong demand for this asset class, underlying values have risen for all three of PIMCO's NY municipal debt funds.
The purpose of this article is to evaluate the New York Municipal Income options from PIMCO, specifically, New York Municipal Income Fund (PNF), New York Municipal Income Fund II (PNI), and New York Municipal Income Fund III (PYN). While municipal ((muni)) debt is an asset class I have favored for a while, I continue to especially favor it for residents in high-tax states, such as New York or California. PNF has been a fund I typically cover and favor as an investment to play this trend. However, in the short term, the fund's premium to NAV has soared, making the risk-reward opportunity much less attractive at current levels. Fortunately, PIMCO offers alternative muni debt funds with a New York focus and one, PNI, is trading essentially at par. This is rare for PIMCO CEFs over the past few years, and has me quite interested in positions.
From a broader perspective, I feel investors will continue to benefit from New York muni debt. The state has been disproportionately impacted by limited SALT deductions, which has sent demand for tax-free income soaring. With tax code changes unlikely until after the next presidential election, this trend should remain in place for some time. Furthermore, the state has seen recent tax increases in local jurisdictions, which has compounded the desire to shield income from the IRS. Finally, while some news headlines suggest a mass exodus of residents out of New York, both the state and NYC have seen job growth on a year-over-year basis, with NYC's growth rate surpassing the national average.
First, a little background about these funds. They all seek to "provide current income exempt from federal, New York State and New York City income tax." This involves investing primarily in municipal bonds that pay tax-exempt interest, including general obligation bonds or revenue bonds, which are tied to a specific project or other revenue source. While I have favored PNF for some time, its current premium to NAV has made me cautious. While the fund has continued to push higher despite my concerns, I am not chasing returns here. Instead, I find some inherent value in PNI, which is currently trading at $11.95/share and yielding 4.02%. Throughout this review, I am going to compare PNI's metrics against the other PIMCO options, as well as provide my macro outlook for NY municipal debt as a whole. After the review, it should be clear why I favor PNI as an investment at this time.
A Comparison Of Important Metrics
To begin, I want to take a look on the surface at each fund and compare them, to help guide an investment choice going forward. All three funds are made up of similar assets, and their objective in obtaining tax-free muni debt within New York makes the comparison relatively easy. If investors have a bullish outlook on muni debt as a whole, all of these funds would likely fit the bill. Therefore, comparing the underlying performance and cost of ownership of these funds can help with the decision of which one to buy.
In this light, I have compiled some relevant metrics for each, to get a sense of how they stack up against one another, which are shown below:
Fund PNI PNF PYN Current Premium 0.7% 12.2% 1.1% Current Yield 4.0% 4.5% 4.4% YTD NAV Gain 11.3% 11.1% 10.2% 1-Year Share Price Return 5% 14% (2)%
As you can see, underlying performance has been fairly similar across the three funds, which makes sense given the only modest differences in individual holdings. Furthermore, the yields are also in the same ballpark. However, a stark difference between the funds is the premium to NAV. While PYN and PNI have only slight premiums, PNF appears quite expensive to own. With a premium in the double-digits, I would be very cautious on new positions at this level. In fairness, PNF does have the highest yield of the bunch, but I don't believe the advantage there is large enough to justify the cost to buy now.
On a related note, I also compared the recent income metrics from PIMCO's September UNII report. While the premium metrics left me with a neutral stance on whether PNI or PYN was a preferred choice, the income metrics put the favor squarely with PNI. While these metrics can fluctuate from month to month, PNI clearly has the most positive momentum in the short term, as shown below:
My takeaway here is mixed, but tends to favor PNI. While none of the funds sport a healthy UNII balance, PYN raises a red flag because its balance is negative, unlike the other two funds. Furthermore, PNI has the best coverage ratios out of the bunch. While the fiscal year-to-date ratio above 100% is certainly positive, what really gets me excited is the improving nature of the metric. With a 3-month rolling ratio of almost 109%, PNI is illustrating that the fund is improving its earnings capacity in the short term. While PYN also has a slight improvement in the short term, PNF does not, and both of those funds have fiscal-year-to-date ratios below 100%. When we consider that PNI is also the cheapest fund to own (in terms of premium to NAV), my initial comparison leaves me favoring PNI quite clearly.
Review of Recent Distribution Cuts
On this light, I do want to cover a recent negative development for all these funds. Back in April, PIMCO announced distribution cuts for a number of CEFs, including all three NY muni funds. While this is old news, it is worth highlighting because reliable income is paramount for CEF investors. While each fund has maintained its adjusted income level since that announcement, I want to highlight the corresponding drops in current income, shown below:
Fund Previous Distribution Change in Distribution Percent Change New Distribution (as of 4/1/19) PNF $.0570/share ($.00399)/share (7%) $.05301/share PYN $0.04225/share ($0.00676)/share (16%) $0.03549/share PNI $0.05069/share ($0.010645)/share (21%) $.040045/share
As you can see, the cuts were quite substantial, except for PNF. This likely explains why PNF has managed to perform better in the short term, and why its premium has risen so consistently. Income cuts around 20% are never a positive sign, so investors were right to approach PYN and PNI cautiously.
However, while I never like to see distribution cuts, I feel more comfortable recommending PNI now for a couple of reasons. One, the fund has paid out its new distribution rate for six months, which shows some stability that investors were likely desperate to see. Two, its current income metrics, as I noted above, are quite strong. PNI is clearly earning, for now, enough income to cover its new income level. While I would not necessarily suggest jumping "all-in" until we see at least a full year of stable payouts, I am willing to take a chance on PNI post-cut. The fund is trading at a reasonable level, at par value, that it makes me comfortable initiating positions, especially when compared to funds like PNF. While PNF saw a smaller distribution cut, its premium to own outweighs this differential, in my opinion.
New York Seeing Job Growth, Wage Growth Picking Up
I now want to shift gears and discuss my broader outlook for New York municipal debt as a whole. Generally, my view is positive, and this outlook will benefit funds such as PNF, PYN, and PNI alike, as well as other NY-focused muni funds from other asset managers.
To begin, I want to touch on job growth figures, which is certainly a primary driver for robust local economies. While recent articles have come out detailing how New York is seeing a net outflow of residents, I believe fears of this hurting the economy are a bit overblown. For one reason, job growth remains strong in New York, and especially in NYC (where the majority of muni bonds originate). To illustrate, the following chart shows year-over-year job growth figures for the U.S., New York State, and NYC, as of July 2019:
Source: New York State Department of Labor
While job growth for New York State is coming in below the U.S. average of 1.5%, job growth in New York City comes in well over the U.S. figure, at 2%. This tells me NYC is not really "falling behind" the country, even if they are currently losing some residents. Job growth figures are strong, and that is sure to boost the tax rolls within the state and city. Furthermore, this 2% figure is an acceleration of the longer term average. To illustrate, consider that the annual job growth gain from 2000-17 is just over 1%, according to data compiled by Bloomberg, shown below:
While the purpose of showing the above graphic was to highlight the short-term improvement in job growth, readers are likely drawing some concern from the "wage growth" trend also reported. According to this data, NYC, despite the job gains, has averaged negative wage growth over the past seventeen years. Clearly, that is not a positive trend, especially when personal taxable income implications are considered. Therefore, a critique of this metric is warranted.
Fortunately, this is another area that has seen short-term progress. While there is no denying the longer term weakness, recent earnings figures show NYC is again beating the national average in 2019. To illustrate, consider that from Q2 2017-Q2 2018, NYC wage growth lagged the national average. However, more recent figures from Q2 2018-Q2 2019 show NYC handily beating the U.S. wage growth average (for private employees), shown below:
Source: NYC Comptroller
My takeaway here is fairly positive. While NYC, and New York State as a whole, certainly face fundamental and structural challenges, the economy seems to be performing well for the time being. Job growth is solid, and wage growth is not only beating the U.S. average, but is increasing at a rate almost double what it was in the prior-year comparison. These figures give me comfort that revenue streams to New York tax authorities will grow, which is good news for muni debt holders.
Looking Ahead To The 2020 Budget
Lastly, I want to highlight a couple of positive developments located within the 2020 fiscal year budget. After reviewing the NYC Comptroller's summary of the budget, I see a few reasons to be cautious, but also to be optimistic. On the downside, NYC is facing the same challenges as all major cities. With growing demands from liabilities such as pensions and social services, NYC will need to continue to demonstrate financial prudence and revenue raising abilities to meet future obligations. With this in mind, I view NYC's projected 1.6% in spending to be mixed. While not an alarming amount of spending growth, NYC will need to continue to find ways to increase revenue without setting off an unsustainable imbalance. While the extra spending funds are going to worthy causes, such as early childhood education, these expenditures do need to be paid for, and issuing bonds/taking on more debt is not always the answer.
On the bright side, there are some reasons to be optimistic. One, tax revenues are projected to grow by 3.4% in FY 2020 over FY 2019, which is an encouraging sign. Two, NYC has undergone what it calls a "Citywide Savings Program," aimed at finding ways to control spending. Currently, the net impact of the program is expected to save almost $6 billion through FY 2023 (in total, not annually). Savings are currently being derived from debt service savings, funding-shifts, accrual savings, and vacancy reductions. Three, NYC's pension investments earned 7.24% in FY 2019, which is higher than the actuarial interest rate of 7%. This excess return boosts the actuarial asset value on the books, resulting in savings that will be phased in over six years.
PNI hit my radar screen due to its attractive valuation, and I have decided to pick it up because I feel its current risk-reward proposition bests the two alternative PIMCO funds. I continue to be bullish on muni debt, but given the strong performance the sector has returned in 2019, I recognize that finding "value" can be difficult. I believe PNI fits this bill. The fund trades at par, its income production has improved in the short term, and I remain bullish on New York muni debt as a whole. Furthermore, for investors who are spooked over concerns of a possible near-term recession, muni debt has a proven track record of performing well during recessionary periods. In fact, many muni bonds offered positive returns during 2008 and 2009, as shown below:
With this in mind, I believe PNI, and muni debt in general, has quite a bit to offer investors going forward, regardless of their economic outlook. Therefore, I continue to recommend investors consider this asset class at this time.
Disclosure: I am/we are long PNI, PCK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.