Muniland’s dynamic living entities
This is an absolutely perfect muniland discussion between Matt Fabian of Municipal Market Advisors, Tom Keene of Bloomberg Television and David Kotok, chief investment officer at Cumberland Advisors. For people unfamiliar with the muni market it really shows how fluid and dynamic conditions are for state and local issuers. It’s really worth listening to several times.
Matt Fabian is one of muniland’s brightest stars and really does an excellent job debunking some common myths about muniland. For example, some predicted there would be hundreds of billions of dollars lost in municipal defaults this year; so far there has been $1.2 billion. For a year Fabian has been saying we would not have a lot of defaults.
It’s at minute mark 6:50, though, where I would challenge Fabian. Contrary to conventional wisdom, as well as the signals from credit ratings and credit-default swaps, he says he would buy the state bonds of California and Illinois. These two are considered some of the worst of state issuers with very heavy debt burdens. Fabian’s rationale is that there are “structural protections for bondholders,” meaning that state law has deemed interest and principal payments to bondholders more important than any other payments the state is required to make.
But the thing I wonder about and would challenge Fabian on is the increasing use of bank loans by state and local borrowers. For example in July of this year California borrowed $5.4 billion as a bridge loan from Wall Street in case the federal government shut down and halted payments to states. California quickly repaid the loan and they have done a good job of disclosing the terms of their borrowing. Nevertheless, states and municipalities have no legal requirement to disclose these borrowings. They are really off balance sheet, at least until their annual audited financial statements are filed, which can mean a delay of a year or more. The MSRB has been examining muni bank loans and has asked the SEC for more guidance. From Bloomberg:
Officials with the Municipal Securities Rulemaking Board, which writes regulations for the $2.9 trillion tax-exempt bond market, have discussed the issue with the Securities and Exchange Commission, Alan Polsky, chairman of the MSRB, said on a conference call with reporters today.
“The SEC and the MSRB are both concerned about bank loans,” Polsky said.
Standard & Poor’s in July estimated that municipalities may borrow as much as $75 billion from banks this year, while Fitch Ratings has also said localities should disclose information about such direct deals with banks. The MSRB, based in Alexandria, Virginia, said in August that loans could fall under some securities rules. It is urging the SEC to weigh in on the matter.
The loans may leave investors unaware about rising debt obligations that could affect their credit ratings, Polsky said.
So Fabian is right to reference “structural protections” for bond payments. But it’s the dark, unknown borrowing that might have more seniority that we don’t know about.