MuniLand

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.

It’s a little frustrating to hear commentators outside of muniland bash all municipal bonds as though they were a homogenous asset class. AOL’s Daily Finance ran a quote from the top regulator at the Municipal Securities Rulemaking Board, who is pushing back on this idea:

“It is important to remember that only four to six [defaults] make headlines, but 45,000 others are doing OK,” Lynnette Kelly Hotchkiss, executive director of the Municipal Securities Regulation Board, tells DailyFinance. “Remember that every issuer is unique and needs to be analyzed on its own merit.”

Reuters is running with the meme that the municipal bond market will likely be resilient in the face of Standard & Poor’s downgrade of the United States. Bloomberg is sailing in the opposite direction with a gloomy view of the prospect of downgrades for munis after S&P’s action. The Bond Buyer reports that low expected issuance should help buoy yields. And the Wall Street Journal details how muniland has passed a critical threshhold in the second quarter as municipalities were able to renew and renegotiate their bank backstop agreements:

There are many financial linkages between various levels of government in muniland but everyone eventually has to stand on their own. It’s like the cousin you grew up with but don’t see much now other than holidays. When your cousin loses their job and their mortgage is being foreclosed you want to help but in a limited way. You want the cousin to get a job and cut a deal on their mortgage or do a short sale. You don’t want them moving into your home or having access to your bank account. It’s the same between the federal, state and local governments. They are cousins. But not that close.

My fellow Reuters blogger, Felix Salmon, said yesterday that states are considered too-big-to-fail by the financial markets:

There’s certainly a general understanding, in the markets, that California is too big to fail: if push came to shove, the federal government would bail it out rather than let it default.

There has been a lot of discussion over the past few days about whether the United States deserves a triple-A rating. The weak and meandering attempts of the Congressional leadership and President Obama to reach a consensus on raising the debt ceiling has prompted this storm of confusion. The political theater is painful.

Most of the talk about ratings revolves around whether the level should be lowered one or more notches. But in The Telegraph today Ambrose Evans-Pritchard goes further and says it’s not really that important whether the United States retains a triple-A because the credit rating agencies don’t have the credibility to strip the rating to the world’s largest sovereign debt issuer (emphasis mine):

Yes, the US may be stripped of its AAA by Standard & Poor’s. A nice one-day story, but otherwise irrelevant. Global bond vigilantes are quite able to make their own judgement on the substantive default risk of the US. The rating agencies are out of their league on this one.

A quick and dirty way to evaluate the credit quality of a borrower is to look at his debt load relative to revenues. It’s not a perfect measure — it doesn’t take into account whether that debt is repaid over many years or whether it’s all due at once, for instance — but it suggests why investors view some states as better risks than others. I’ve made a set of charts so we can compare debt loads and revenues for the states in a simple, visual way. The amount of debt load is indicated by the full height of the bar. (Please note the vertical scales of the charts vary. California is the highest borrower by far.)

I’ll do another series of charts that includes pension liabilities and other post-employment benefits, and I’m warning you now: that set will look scary. Here is a link to these data and charts in interactive format. Feel free to embed and use them elsewhere (crediting Reuters of course).

Tax collection data is from the U.S. Census Bureau and debt load data is from Standard and Poor’s.

More alarms are ringing in muniland today. Moody’s issued a statement announcing that it was putting on review five states which have Aaa ratings. Aaa is Moody’s highest rating, and the agency is concerned that knock-on effects from the federal government could weaken the ratings of these states.

I made this chart detailing the specific rationale Moody’s used for each state from the statement they released today. Note that states which have a large dependence on federal jobs and contracts dominate the list. ————– Sensitivity to natl trends Fed workers as % of employment Fed contracts as % of state GDP Medicaid as high % of budget Low rainy day fund Maryland *** *** New Mexico *** *** *** South Carolina *** *** *** Tennessee *** *** *** *** Virginia *** *** *** ***

From Credit Sesame (click through the map above for an even better interactive version):

Other than their mortgage, most home owners’ largest home-related expense is their property tax bill. And it’s no secret that when it comes to property taxes, some states are much harsher than others. Consider this: In 2009, New Jersey home owners paid an average of 27 times more in property taxes than property owners in Louisiana. Ouch.

Hat tip to The Big Picture.

Potential U.S. rating downgrade rattles muniland

Bloomberg reports:

At least 7,000 top-rated municipal credits would have their ratings cut if the U.S. government loses its Aaa grade, Moody’s Investors Service said.

If you’re bad, you pay

Ever wonder why fixed-income investors are often called “bond vigilantes?” Just as a banker charges a homeowner with a bad credit history a higher mortgage rate, bond investors make borrowers pay more if they have a heavy debt load and weak revenue sources. Investors use higher interest rates to crack down on borrowers; the interest rate is higher because there is more risk.

I thought it would be helpful to visualize the credit quality data that Thomson Reuters Municipal Market Data regularly publishes for states and large cities. The higher the interest rate, the greater the perceived risk in lending to these public entities.

The chart above shows the additional interest rate that a public entity pays over the benchmark AAA interest rate. As you can see, Puerto Rico is far and away the riskiest borrower.

Quis custodiet ipsos custodes? Or “who watches the watchmen?” Credit-rating agencies are the main watchmen of the financial system.  But can we judge their performance, or are they just black holes filled with “opinions?”

The credit-rating agencies continue to make headlines as they try and keep pace with a slowly sinking Europe and the efforts there to rescue bondholders. European banks, the ECB, and officials from the EU are trying desperately to concoct some kind of structured investment vehicle that will solve the Greek sovereign debt crisis without requiring a default. So far, the rating agencies are not eating their “inventive” cooking, and they have yet to bless any new “solution.”

Many observers believe that credit raters completely mis-rated mortgage bonds and that this caused the global financial crisis. Meredith Whitney implies that credit raters are vastly underestimating the riskiness of municipal bonds and have overlooked pension and other liabilities when judging state and local governments’ creditworthiness. But do we have any statistical evidence of any this? Are credit raters getting the ratings wrong on every type of bond?

Has Chris Christie “fixed” the problem?

Joan Gralla of Reuters reports that Governor Chris Christie will be signing the pension and health-benefit reform law today. This is an important step for the health of New Jersey’s pension plans, and Governor Christie should be lauded for his accomplishment.

The state’s 2010 Debt Report (page 15) said that they have $87.5 billion in unfunded liabilities as of June 30, 2009 and that the rate of increase has gone up substantially in recent years:

$30.7 billion for the seven major state pension funds $56.7 billion in unfunded post retirement health benefits

Unfortunately Governor Christie has skipped payments of $5.5 billion over the last two years and compounded these unfunded liabilities. One of these skipped payments was used to claim a “balanced budget.” Your household budget is not really “balanced” if you skip your car loan payment for a year.