What happens to muniland in 2012?
It looks like smooth sailing for the municipal bond market in 2012, according to three senior market participants who exchanged views at the Fitch Ratings 2012 Municipal Credit Forum. Continued strong demand for municipal bonds, ongoing low bond issuance, favorable Federal Reserve rate policy and major banks upping their direct loans to municipal entities will make 2012 another strong year.
Estimates of how many new municipal bonds will be issued in 2012 ranged from $300 billion to $350 billion. George Friedlander, a municipal strategist at Citigroup, dug a little deeper than the gross numbers and discussed the maturity profile of the municipal debt market. He talked about “bond years outstanding,” which is a new concept to me. Friedlander explained that with the massive amount of bond refundings that are happening in this low-interest-rate environment, the overall maturity of bonds outstanding is contracting. Or, to put it another way, as municipal bond issuers call long maturity bonds, they are replacing them with shorter duration bonds at lower interest rates. This shrinks the amount of bonds available in the 15-30-year range. It could help explain the new lows that the Thomson Reuters MMD AAA scale keeps hitting for longer maturity bonds. Friedlander had estimated that there was $90 billion more in bond refundings in 2011 than new issuance.
Given that refundings took up a big portion of 2011 bond issuance, Friedlander projected that there was $170 billion of “new money” that flowed into muniland last year. Much of the cash invested in the muni space was “old” money that investors had from their refunded bonds. This would help explain the meteoric performance of muniland in 2011, and it’s likely to have big implications for 2012.
On the demand side Sean Carney, a vice-president and municipal strategist at BlackRock, said that it had been incredibly strong and broad-based, especially when Treasury-muni ratios were above 100 percent, a widely used industry ratio for comparing return on federal and municipal debt. He also said that retail investors were getting comfortable buying longer-maturity and lower-rated bonds.
Thomas Doe, founder and chief executive of Municipal Market Advisors, said that many community banks had entered the municipal bond market as buyers. He said that over 5,000 community banks now own muni bonds, which was more profitable for them than making loans. Doe also discussed the activity of large banks making direct loans to states and other municipal entities and suggested that about one short-term loan a week was being made. He said that bank loans have the potential to become a permanent part of the municipal market but disclosure and loan covenants remained an issue. BlackRock’s Carney said that essentially all banks loans were being done by three major banks. Citi’s Friedlander said that the capital requirements of Basel III and a higher Fed funds rate could slow big bank direct lending. Currently big banks are capturing the arbitrage between their near-costless short-term borrowing and the higher rate they charge municipal entities to borrow funds.
BlackRock’s Carney said that they had been closely watching the proportion of interdealer trades to customer buys and sells. January had an unusually high level of trades between dealers, which reduces yields on bonds as dealers bid up the securities. Carney said that on average interdealer trades run about 14 percent of monthly trades, but January saw 24 percent of total trades done between dealers. BlackRock prefers fewer trades between dealers because dealers run up the price of bonds and they, rather than market participants, capture the profits.
All seems well in muniland. I met many interesting people at the event, and I’ll be writing up some of their views on differect sectors of the municipal market.