Muni sweeps: Increasing the muni investor pool

By Cate Long
April 18, 2011

It’s a glorious spring day in America and everything continues to bounce along. A little progress here and some fall back there. Oh and that unpleasant negative ratings watch on United States debt from Standard & Poor’s. Yeah that is not good. Welcome to a new week in muniland.

The sun sets over a pond in Rogers, Arkansas, November 8, 2009. REUTERS/Lucy Nicholson

The sun sets over a pond in Rogers, Arkansas, November 8, 2009. REUTERS/Lucy Nicholson

Increasing the muni investor pool:

Marketwatch has an article which frames the proposed Wyden and Coates federal legislation for muni tax-exemption as having the effect of shrinking the investor pool.

I think this is a good frame to think about tax changes within. Whether they broaden the pool of investors for municipal debt or narrow it.

Build America bonds helped the muni market because they attracted new investors.

One of the  big shortcomings of the current tax treatment of muni bonds is there is no advantage to holding them in tax free retirement accounts. Which means less affluent investors cannot take advantage of their tax exemptions.

Bank of America Merrill Lynch analysts think

the legislation would make “munis less attractive to investors in higher tax brackets, but more attractive to investors in lower tax brackets,” John Hallacy, a municipal research strategist at the firm, wrote in a note. “However, since lower-tax-bracket individuals are less likely to buy bonds, the result would likely just be less demand for munis from retail investors and higher financing costs for issuers.”

I disagree very strongly with the Bank of America Merrill Lynch analysts. I think the less affluent would buy municipal bonds as readily as they buy CDs if they made sense in their retirement accounts.

I still think it highly unlikely that the Wyden-Coates legislation will move forward in the Senate but it would be excellent to put less affluent investors on par with well-to-do ones.

NCSL new database  on state budget gaps:

The National Conference of State Legislatures will host a free webinar April 19 to talk about their new state budget database.

The recession may officially be over, but states are still grappling with its effects. With the American Recovery and Reinvestment Act funding coming to an end, crafting fiscal year 2012 budgets is proving to be challenging.

How big are the budget gaps facing the states?  How are state revenues performing?

This session will provide information from NCSL’s March 2011 State Budget Update survey of legislative fiscal offices and the latest revenue performance data from the Rockefeller Institute of Government. NCSL will also demonstrate a new database with information on the measures that states have been taking to close their budget gaps.

Recovery amount is important for defaults in muniland

Rockfleet Financial has done one of the best analysis of potential losses from defaults in the muni market. My only objection is that it doesn’t address the issue of municipal derivatives.  Which may be our real muniland monster.

Many have voiced their opinions on why “hundreds of billions” of defaults in municipal securities within the year is an inaccurate reflection of the market.

Promoting outlandish default predictions does a disservice to the investing public, as well as to the issuers, rating agencies, insurers, credit analysts, portfolio managers, and other market participants who work diligently to provide their respective services.

We analyzed the numbers to determine what’s really at risk, using a more pragmatic approach. While bankruptcy and default statistics are important, the ultimate recovery rate to the investor is what’s really at stake, and where the focus should lie.

We have concluded that investors may suffer unrecoverable losses in the range of $10-20 billion over the next ten years.

Interestingly Rockfleet estimates the size of the muni market at $4 trillion when most, including SEC Chairman Shapiro, say the market is about $3 trillion.

World Trade Center problems

The Wall Street Journal has an excellent article today about the real story of the Silverstein/Port Authority deal being pulled for the second time last week. This one may take a while to resolve.

A group of institutional investors has helped delay a planned $1.3 billion bond sale meant to finance construction of the 4 World Trade Center over concerns about how the deal is structured.

The investor group, which includes mutual-fund giant Fidelity Investments, holds stakes in the general debt of the Port Authority of New York and New Jersey, which is backing the debt of Tower 4.

The group is concerned the new debt would be senior to existing debt, and that issuing it would erode the value of their holdings. They say bond documents don’t permit senior debt to be issued, a point the Port Authority contests.

Insure bonds which are not likely to default?

The municipal bond insurance market is almost entirely gone. Today 5% of muni bonds are insured versus 57% in 2005, according to Thomson Reuters.

This is because most of the major bond insurers, after having extended their insurance book to cover RMBS and CDOs, blew up in the credit crisis. Also Barney Frank, when chairman of the House Financial Services Committee in 2009, forced the credit rating agencies to equalize the rating scales between corporate and municipal debt. This forced a systemic upgrade of municipal ratings and substantial decrease in the need for bond insurance.

Now the lone remaining bond insurer, Assured Guaranty Municipal has begun offering insurance policies on about 5,000 new and existing municipal bonds to retail investors.

They offer this service as a one-click option on sales larger than $100,000 on the bond platform MuniCenter.

Smartmoney addresses whether this is smart.

Many financial advisers, however, disagree, cautioning that bond insurance makes little sense for most investors. “It may be nice fall back for people psychologically, but insurance has never really been needed,” says Anthony Valeri, a fixed income strategist for LPL Financial.

Indeed, Valeri and others say the credit concerns that sparked the $40 billion selloff in muni bond funds that started last November are overblown and the chance of defaults remains low.

Even in the case of a default, investors usually recover up to 80% of their investment on highly graded municipal bonds, according to MMA. Another risk is that the insurer itself may not survive the next five years or more, says Josh Gonze, a municipal bond fund manager for Thornburg Investment Management. “What if the bond insurer is not around in 10 or 20 or 30 years?”

Little sweeps:

Bond Buyer: Week 22: Muni Mutuals Lose $834M

Reuters: States, cities brace for budget deal cuts

Bloomberg: Broke U.S. States’ $48 Billion Debt Drives Unemp Assistance Cuts

American City & County: New database gives quick access to state and local pension data

State/Local Funding Report: Fiscal Challenges Come Home to Roost Locally

Stateline: State budgets are better, but still bad, officials say

Tax.com: Really Bad Reporting in Wisconsin: Who ‘Contributes’ to Public Workers’ Pensions?

Distressed VolatilityDetroit’s 2011-2012 Budget, $200M Savings Needed

Bond Buyer: B of A Gives Assured $850M as Part of $1.1B Settlement

Financial Times: US county can sue JP Morgan over bond deals

Barron’s: Judgment Day Approaches

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