“Muniland a quiet backwater today”
Muniland was quiet today as market participants confined the bloodbath to the equity markets. Investors mainly sat on the sidelines and benchmark yields were unchanged. The Thomson Reuters Municipal Market Data 10-Year AAA Scale closed at 2.38%, unchanged from Friday. Reported volumes were light.
The worst muniland event of the day occurred when Moody’s announced that they had cut Puerto Rico’s general obligation debt rating to Baa1, a level close to the bottom of the investment grade scale. Because it is a territory, Puerto Rico has the unique distinction of enjoying national exemption from local and state taxes, so its debt is widely held across America. It is also among the cheapest municipal bonds available because the market believes it has some likelihood of default due to high levels of debt and unfunded pension liabilities.
The muniland non-story that commanded headlines was the expected downgrade of state and local bonds due to the Standard & Poor’s downgrade of the United States. Chris Mauro of RBC Capital Markets has some very good analysis about the arcana of this market and how the headlines are wildly overblown:
Because most municipal bonds are structured with serial and term maturities, the $2.9 trillion municipal bond market contains about 1.2 million individual CUSIPs, compared to about 75,000, for example for the US corporate bond market. As a result, S&P’s anticipated downgrade of pre-refunded municipal bonds and other directly linked bonds will, in the aggregate, produce a very attention-getting headline number.
We anticipate that most media outlets will run with this figure and highlight “thousands of municipal bond downgrades” in their headlines. We note, for example, that Moody’s, in its July 13, 2011 report on the potential implications of a US rating downgrade, identified 7,000 directly linked municipal ratings with approximately $130 billion in par value. Our immediate concern is that these kinds of headlines will prompt retail investors to engage in another wave of mutual fund selling.
And here’s Chris on the more substantial problems facing muniland when the congressional “supercommittee” gets to work (emphasis mine):
We anticipate that any rating action on bonds other than those directly linked to the federal government will be limited. S&P will attempt to quantify the impact of federal deficit reduction on state and local government budgets, but we think any rating changes resulting from this exercise will be minor. Federal discretionary spending makes up only a modest portion of state and local budgets on average.
Mandatory federal entitlement spending is a much more significant component. Therefore, the more considerable deficit-related fiscal pressure will hit the states when and if Congress undertakes meaningful entitlement reform.
Muniland dodged a bullet today. Municipal bond investors are not as skittish as equity investors because entering and exiting positions is relatively expensive. There will be pain ahead for muniland, but not today.
Wall Street Jounal: States, Muni Bonds Brace For Fallout From U.S. Rating Downgrade