The concerns building in the private-credit industry are starting to inflict pain in a rapidly growing segment of the US municipal debt market.
The anxiety around private credit, where firms have faced high-profile blowups and redemption requests, has roiled select munis in a sector known as prepaid energy bonds. These securities allow municipal utilities to buy electricity or natural gas at a discount by locking in decades of supply upfront — savings they can pass on to customers.
Investors point to deals involving insurer Athene Annuity and Life Co., which is owned by Apollo Global Management Inc., one of the big asset managers whose shares have slid amid private-credit jitters. Some of these prepaid energy bonds have weakened more than benchmark munis, which are slumping along with the rest of fixed income as soaring oil prices spark inflation concerns.
As part of the deals’ complicated structures, a middleman — often banks or insurance companies — receives the proceeds from the bond issues, which they can invest. Those funding recipients — such as Athene — then make regular payments needed to procure the energy for the utility. That’s why Moody’s Ratings, which assesses many prepaid energy bonds, typically cites the credit quality of the provider of funding agreements when it rates deals.
Investors have demanded extra yield on deals involving Athene, trading data over the past month shows, suggesting they’re worried the insurer won’t be able to keep up its end of the bargain if it starts to face losses on its private-credit investments.
One example of an Athene-linked energy bond that’s been affected is a security sold in 2024 through a California agency. Investors have required almost two percentage points of extra yield above top-rated munis, on average, to buy the debt since the start of March, including at some of the widest spreads since it was issued. That’s up from an average of around 1.7 percentage points in February.
Other bonds tied to Athene have also seen spreads increase, including a deal sold last year by an Alabama entity and another issued through a New York agency.
Athene’s ties with Apollo are part of the explanation, according to Jude Scaglione, head of municipal credit research at Alvarez & Marsal Private Wealth Partners. The other factor is angst about potential private-credit losses within the insurer’s portfolio, he said. The combination shows the importance of knowing the intricacies of prepaid energy deals, he said.
“You really need to understand it if you’re going to invest in it,” he said.
In an emailed statement, Athene noted that tax-exempt yields on prepaid energy munis have risen amid broader macro volatility.
“Spread performance on certain municipal prepay transactions in which Athene has issued its funding agreements do not accurately reflect the underlying strength of our balance sheet or credit quality of our portfolio, which is 97% investment grade with levered lending levels that round to zero,” the firm said.
Booming Segment
The weakening in the Athene-linked debt highlights the risks within a part of the muni market that’s seen record-breaking annual issuance since 2022, and now tallies more than $100 billion in outstanding debt, data compiled by Bloomberg show.
Scaglione and other investors say most prepaid energy bonds have been experiencing volatility similar to the rest of fixed income during the war in Iran. But the transactions’ complex structure helps explain why some can be whipsawed by events that shake the finance industry, as seen in episodes such as the 2023 regional-banking crisis.
JPMorgan Chase & Co. strategists, in a report late last month that noted weakness in the prepaid gas sector in March, said spreads have diverged based on funding recipients.
“Entering March, prepay bonds backed by insurance companies significantly lagged those backed by banks,” they wrote.
Banks and insurers have been drawn to the space because of the low borrowing costs in munis, according to a report from Goldman Sachs Asset Management. These funding recipients, as they’re known, benefit because the deals let them borrow at tax-exempt rates and invest the proceeds at taxable rates, allowing them to profit from the difference, a report from American Century Investments says.
The deals typically carry investment-grade ratings, but because of their complexity, the debt generally offers investors higher yields.
Athene has been involved in about $6 billion of prepaid energy bonds sold since the start of 2024, data compiled by Bloomberg show.
Last week, Apollo President Jim Zelter downplayed investor concerns about private credit, describing recent developments in the asset class as “growing pains.” Apollo was among top asset managers whose shares fell that day, however, after Blue Owl Capital Inc. said it will limit redemptions from two of its private-credit funds.
Apollo didn’t respond to an emailed request for comment.
Portfolio Scrutiny
Athene’s roughly $292 billion investment portfolio has drawn scrutiny for its private-credit holdings. However, high-grade fixed-income securities dominate the holdings, according to Bloomberg Intelligence.
“Athene’s strategy has worked, with significant excess yields and minimal losses,” BI analysts David Havens and Nicole Castelblanco wrote in a March 31 report.
Shannon Rinehart, co-head of muni investments at Columbia Threadneedle Investments, said the selloff in prepaid energy bonds linked to the insurer was driven by concerns around Athene’s exposure to private credit.
But even though she said current levels are attractive and she’s been buying prepaid energy bonds involving Athene, her view is that the bonds should offer elevated spreads.
“There’s just less transparency with the private equity-owned insurers, so there should be a spread premium involved,” she said.
For prepaid energy issues with more exposure to private credit, there’s “clearly more pressure on them,” said Mikhail Foux, who leads muni strategy at Barclays Plc. But “if you have wider spreads that could potentially be an opportunity.”
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