Winners and losers in a hot municipal market
Like U.S. Treasury debt, muniland securities have been hot, hot, hot. Investors have been piling into municipal bonds for about 16 consecutive months. At first, demand was driven by investors who were attracted to the high yields in the wake of Meredith Whitney’s predictions of default, which scared retail investors out of the market between November 2010 and February 2011. Demand then accelerated as the Federal Reserve kept interest rates at artificially low levels, driving investors out of Treasuries and into riskier assets. Steady municipal bond mutual-fund flows, coupled with the reinvestment of muniland proceeds into new bond issues, has also helped keep demand elevated.
On the supply side, municipal bond issuance in 2011 slowed to $295 billion, down 32 percent from 2010 and the lowest level since 2001. This lack of supply, along with massive demand, has covered over a lot of issuer weaknesses that would normally drive yields higher. Bloomberg reports:
“There’s a shortage of bonds out there,” said Paul Mansour, managing director at Hartford, Connecticut-based Conning, which oversees about $10 billion of municipal bonds. At the same time, “there’s a rush for yield, and it’s masking the differences” in issuers’ credit quality, he said.
One of the beneficiaries of this dynamic has been California. Its bonds have been enjoying strong demand even as the governor announced larger-than-expected deficits last week. Bloomberg said:
The extra yield on issues from California, the lowest-rated U.S. state by Standard & Poor’s, fell to 0.82 percentage point [82 basis points] last week, matching the smallest since December 2008, according to data compiled by Bloomberg.
Although the market has tremendous momentum, some issuers are being left out. For instance, investors are wary of Illinois debt, which has averaged 160 basis points over the last year. Another one of the laggards is Puerto Rico. As seen in the chart below prepared by Daniel Berger of Thomson Reuters MMD, the spread of Puerto Rico’s debt over the MMD AAA benchmark has remained relatively flat over the last year, hovering around an average of 219 basis points.
President Obama, the Ricketts family and Wrigley Field
Is the Ricketts family of Chicago bipolar? The patriarch, billionaire and Chicago Cubs owner Joe Ricketts, blasted onto the national stage yesterday, when the New York Times reported that his super PAC considered running an ad campaign entitled “The Defeat of Barack Hussein Obama: The Ricketts Plan to End His Spending for Good.” His super PAC, the Ending Spending Action Fund, also lobbies against excessive federal spending and special-interest earmarks.
Meanwhile Ricketts’s son Tom, the general chairman of the Cubs, has been lobbying Rahm Emanuel, the mayor of Chicago and President Obama’s former chief of staff, for $150 million in tax revenues to renovate Wrigley Field, the home of his family’s Major League Baseball team. The irony of Joe Ricketts blasting the president for special-interest spending while his son grovels for taxpayer support to renovate his baseball stadium is enormous. The Ricketts family needs to meet around their kitchen table and get this matter worked out, because it makes both the father and son look clueless.
Greg Hinz of Crain’s Chicago Business has the local scoop:
Did the Ricketts family just knee-cap its own plan to rebuild Wrigley Field with a healthy dose of Chicago taxpayer cash?
My phone has been ringing with just that question this morning in the wake of a stunning New York Times story about how a new super PAC headed by Joe Ricketts, patriarch of the Chicago Cubs’ owning family, is pondering a big, especially nasty ad campaign against President Barack Obama this fall.
[...]
The Chicago angle on this is that Mayor Rahm Emanuel, Mr. Obama’s former chief of staff, has been trying to put together a deal for the city to put $100 million or more in tax incentives into a Wrigley [stadium] rebuild.
The Wall Street Journal discussed the proposed renovation of Wrigley Field, for which Tom Ricketts wants taxpayer money:
Proposals include more premium seating near the field; a Jumbotron; a new building along Clark Street that could contain a restaurant, parking, and hall of fame; and game-day street fests open only to ticket-holders.
The father’s advocacy group, Ending Spending, describes itself like this:
Illinois says non-profit does not mean tax-exempt
In a series of decisions that may affect healthcare nationally, Illinois is tightening the noose on hospitals that claim tax-exempt, non-profit status. What began as the denial of a property tax exemption by the Champaign County Board of Review for one hospital system in 2002 has become a state-wide analysis of how much actual “charity care” hospitals are providing.
The immediate implication is that hospitals’ property tax exemptions could be revoked and vital revenues could be collected. However, this raises a broader structural question around the use of tax-exempt municipal bonds for entities that may be passive vehicles for for-profit activity.
Becker’s Hospital Review has the specifics:
[T]he Illinois Department of Revenue’s crackdown on Illinois non-profit hospital tax-exempt statuses came on the heels of an Illinois Supreme Court ruling from last year. In 2010, the Illinois Supreme Court ruled that Provena Covenant Medical Center in Urbana, Ill., could not qualify for property tax-exempt status because it did not provide enough charity care to its community, although Provena argued that it provided millions of dollars in other free care and community benefits.
The microscope on Illinois non-profit hospitals does not end there. Chicago Mayor Rahm Emanuel also recently proposed cutting free water and sewage services for city non-profits in October, and Moody’s Investors Service recently released a report that said the revocation of Illinois hospitals’ property tax-exempt statuses could be debilitating to the sector’s finances. “This has implications beyond property taxes,” Mr. Dunn says. “A not-for-profit status is, by virtue, about the level of charity work they do, and this could jeopardize their 501(c)(3) statuses.”
Fitch Ratings had a report today that gave some color on the legal and legislative processes:
Although Illinois Department of Revenue’s decision is based on the grounds that these hospitals do not provide enough charity care to qualify for the exemption, the exact criteria or standards for the IDOR’s decision were not disclosed. Subsequent to the IDOR’s announcement, Illinois Governor Pat Quinn announced that the state would postpone its review of these exemptions until the state legislature had the opportunity to craft legislation that specifies qualifications for the exemption. In March, Governor Quinn ordered the IDOR to continue its reviews as the legislature was unable to resolve the issue.
As the legislative and executive branches thrash out the exact standard for how much charity care a hospital must provide, the deeper issue of for-profit entities using most of the physical space in a tax-exempt, non-profit building needs more attention. The original county review that sparked Illinois to look more closely at non-profit hospitals, that of the Provena Covenant Medical Center, detailed the extent of for-profit activity in the system:
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Muniland’s most active states
In the municipal bond market, one of the most insightful ways to examine a state is to look at how actively its bonds trade. Broker-dealers make money by trading, so naturally they go where the action is and commit market-making resources to those states. It’s generally true that the most populous states are the ones with the most traded bonds, but if we map the wealth of a state’s citizens to how often that state’s bonds trade, we get some interesting results. For example, New Jersey, which has only 2.8 percent of the national population but a high proportion of its wealthy citizens, might have the highest number of municipal bond owners as a percentage of state population.
The municipal bond market does not trade on an exchange but rather on “alternative trading systems” (ATS). These are systems where dealers post inventories of bonds to be aggregated. The largest of the retail ATS is Bonddesk, which does some excellent data analysis for both the municipal and corporate bond markets.
From Bonddesk’s December Transparency Report I pulled the data for these charts showing the seven most actively traded states’ bonds. Bonddesk uses “investor buys” data, which represents trades that end up in a retail investor’s account. In the bond markets there are often many trades between broker-dealers before the securities land in an investor’s account, so Bonddesk scrubs the data to show the real level of investor demand.
California is the largest state by wealth, population and municipal bond issuance. Although it represents about 12 percent of the U.S. population, it dominates with 30 percent of muniland trades. Even with its substantial demand, the state still has somewhat higher yields, as seen below. All seven states are rated AA, but Illinois and California trade with higher yields given their weaker fiscal position.
Tapping the brakes on Illinois debt?
Illinois, the state in the weakest fiscal position, is planning two big bond deals in the first quarter of 2012. Next week they plan to raise $800 million in general obligation bonds to finance various transportation projects, followed by another $750 million later this winter in long-term bonds to fund construction projects.
Although the state is drowning in debt, unfunded pension liabilities and unpaid bills, these debt offerings are very restrained compared to the last two years when it borrowed to make obligatory payments to its heavily underwater pension system.
The State Treasurer, Dan Rutherford, had opposed issuing debt to fund pension obligations and managed to raise the alarm among his former colleagues in the Illinois legislature about the dangers of endless borrowing. Rutherford’s actions may have reversed the momentum of Illinois’s debt issuance. He is certainly the first fiscal officer that I have heard of who threatened to call the rating agencies to slow his state’s bond issuance.
In another important step for the cash-strapped state, Illinois raised the personal income tax last year:
An income tax hike enacted in early 2011 that will raise $6.8 billion in new revenue annually helped ease the state’s cash flow and budget woes, but its unfunded pension obligations still pose a daunting challenge to efforts to stabilize its fiscal house. The state’s funded ratios were the lowest among states last year based on fiscal 2010 results.
The latest review based on fiscal 2011 figures shows Illinois’ unfunded [pension] liabilities rose to $82.9 billion for a funded ratio of 43.4% from $75.7 billion for a funded ratio of 45.4% in fiscal 2010.
The need to fund pension liabilities is crushing Illinois. Reform must be pretty radical to move the system to a more sustainable level of pension funding, but the state government seems to be dithering:
MMD believes that current 10yr IL GO spreads +160bps to AAA GOs will move to the 12mnth average of 176.5bps this week.
Oh Illinois!
Oh Illinois!
Illinois has massive problems: the state has more liabilities than assets, and the credit-default swap market says they are the number one state at risk for default (see chart above). The Bond Buyer ran an excellent story on how the liabilities of Illinois are rapidly increasing:
In a sign of Illinois’ ongoing fiscal challenges, its net assets deteriorated by $8.4 billion in fiscal 2010, pushing its deficit in that category of financial reporting up to a negative $37.9 billion, according to a new report from state auditor general William Holland.
The figure takes into account the state’s accounts payable that were $9.1 billion in fiscal 2010 and $55.1 billion of debt obligations, including outstanding bonds and pension obligations. The figures provide a wider view of a state’s overall long-term fiscal health than the snapshot provided by annual budget numbers.
Even with their credit problems, analysts at Thomson Reuters Municipal Market Data see Illinois’ general obligations bonds as tradeable. From their Municipally Speaking note today:
[T]his credit is not “out of the woods” but nevertheless (perhaps due to higher personal and corporate income taxes) Illinois spreads have decreased quite dramatically.
In January we were very optimistic about investors’ ability to achieve outperformance with Illinois paper. Spreads were +240bps for 5yrs and +223bps for 10yrs.
Today we are more cautious as this credit’s GO trading may be a little bit ahead of itself. Spreads are +140bps for 5yrs and 10yrs.
Insurers have “manageable” muniland risk
Insurers have “manageable” muniland risk
Meredith Whitney has made many assertions about muniland, but the only one that I had not heard from others before she stepped onto the national stage was her contention that insurance companies would be forced to sell their municipal bonds into a declining price spiral. She alleged this would collapse muniland, so it’s very interesting to see Moody’s assess the risk for insurance industry. From Property Casualty 360:
Property and casualty insurers remain the most exposed sector among financial institutions to volatility within the municipal-bond market, holding about $355 billion in municipal bonds, but the overall level of risk should be manageable, Moody’s says.
In a Special Comment, Moody’s says municipal bonds represent 60 percent of the industry’s equity capital base, as measured by policyholders’ surplus. This figure is down from the prior year, when the industry held about $370 billion in municipal bonds, representing about 70 percent of policyholders’ surplus.
Moody’s also says that, as part of its stress-testing of P&C insurers, it projected losses on muni-bond portfolios under both baseline and downside scenarios, and in both cases credit losses were manageable.
The baseline scenario, Moody’s explains, assumes a continued sluggish economic recovery. Under this scenario, credit losses were projected to be $300 million for P&C companies rated by Moody’s, and $500 million for the entire U.S. P&C industry over a five-year horizon.
For the downside scenario, which assumes significant credit deterioration consistent with multi-notch downgrades across the muni sector and high default rates, credit losses could approach between $2 billion and $3 billion, Moody’s says.
Insurance Journal: P/C Insurers Can Handle Muni Bond Stress: Moody’s
Reuters: Insurers can manage U.S. municipal bond risk: Moody’s
Yes, unfunded pensions are liabilities
From Bond Buyer (emphasis mine):
Greening the city
Many cities took a big step forward for clean air when they adopted buses fueled by natural gas. But there are other important projects that will make getting around easier, quieter and less polluting. New York City is getting ready to take a big step. From American City:
New York City has the potential to take those [bike sharing] concepts and scale them up to a size unseen on this side of the Atlantic. Mayor Michael Bloomberg, a man the transportation community has a complicated relationship with, has been dangling a transformative bike sharing program in front of alternative transportation advocates since 2009 when New York’s city planners issued an “exhaustive proposal” that included a 10,000 strong fleet of safety-equipped, GPS-ready bikes.
Economically, the deal is a victory for innovative financing because it fully absorbs the burden of maintenance, damage, and —as this is a city— theft, vandalism, and “artistic destruction.” New Yorkers would buy their memberships on weekly, monthly, or yearly bases and get an unlimited number of free rides that take less than 30 minutes; ride a little longer, pay a little more. New York has decided that an initial burst of capital will serve their purposes the best not least because of their uniqueness among American cities in terms of density and population.
Take with one hand, then the other
A rich guy makes a gain at the expense of his state’s teachers’ pension fund and then asks for public funding for his stadium project. This is now how things should work — the public should just say “enough,” or at least demand more transparency around this deal that lost the teachers’ money. Bloomberg reports:
Philip Anschutz, who seeks taxpayer support for a $1.4 billion downtown Los Angeles football stadium complex, bought out a partner in his nearby hotel and condo project at a loss to investors including state teachers.
California State Teachers’ Retirement System, the nation’s second-largest pension plan, is an investor in a MacFarlane Partners fund that sold its money-losing interest last month in the Anschutz-led Ritz-Carlton and JW Marriott hotels and attached condominiums at the L.A. Live project, according to Ricardo Duran, a spokesman for the pension fund.
“It was sold at a loss, I don’t know how much,” Duran said in an interview yesterday.
[...]
Anschutz’s firm, AEG Worldwide, has asked the Los Angeles City Council to approve a plan to build a $1.4 billion football stadium and convention-center expansion that involves the city issuing $350 million in municipal bonds for the convention- center portion of the project. Part of the existing center would be torn down.
AEG seeks to attract at least one National Football League team to the city, which lost the Raiders after the 1994 season. Revenue from the stadium and convention center addition, along with assurances from AEG, will be enough to repay the bonds, according to Michael Roth, a spokesman for the company.
NJ Governor Christie’s pension win
8 weakest U.S. states
According to the credit rating agencies and the bond markets, these are the 8 states with the weakest credit profiles. These states may be weak because their debts are too big, because their economy is flagging or because they haven’t adequately funded the retirement of their employees. If this were a school, these would be the students sitting in the back of the class. Maybe it’s time for these states to do a little more homework.
We start with the weakest Puerto Rico, a United States commonwealth.
Rearranging the letters, and adding, say, Arkansas, you get, hmmmm, DAMNN PRICs. lol
Illinois’s crack habit
The state of Illinois has been riding the easy governance boat on a river of debt. It has run up its borrowing to fund infrastructure, pension liabilities and unpaid bills. According to state treasurer Dan Rutherford, Illinois’s debt load currently amounts to $198 billion — that is a mountain of debt. The amount is also about 31% of the 2009 gross state product of $630 billion.You get the feeling that Illinois state government is addicted to overspending and debt and just can’t let go of that overdraft account down at the bank.
Reuters describes the fiscal situation:
Even with a big income tax rate hike passed in January, Illinois is still spending about $5 billion more a year than it receives in revenue, according to the position paper, which also said the state’s low bond ratings have resulted in higher borrowing costs compared with other states.
Governor Pat Quinn has been pushing the legislature for anywhere from $2 billion to $8.75 billion of bond authority to pay off bills and other obligations incurred this fiscal year.
His office said in a statement on Monday that this plan is not new borrowing, but a restructuring of debt the state owes to vendors and service providers who have been waiting months for payments.
“Governor Quinn is 100 percent committed to making good on all bills due and feels restructuring debt the state already owes at attractive rates is the least costly option for taxpayers in order to address this bill backlog,” the statement said.
Governor Quinn seems to be trying to move the outstanding balances around between the various credit facilities. That works for a while, but before long lenders shut off the spigot and there is no more credit. The state treasurer Dan Rutherford wants to end the state’s addiction and has been out making the media rounds and banging the fiscal drum (see Bloomberg video above). In addition to media appearances he has written a white paper and threatened to call up the Wall Street banks to tell them not to issue any more debt for the state. This is wild.
In the Bloomberg video he says, “Sure there is always someone who is willing to lend to Greece, Iraq and Illinois but not at a rate that taxpayers should be willing to take responsibility for.”
Attention Governor Quinn! The treasurer of the state is out sounding the alarm and your borrowing costs will be rising. I’m sure big Wall Street banks are proposing many novel ways to juggle the debt and increase the state’s borrowing capacity, but you must be skeptical of the magical fixes. There is no way to escape the budget pain. Public entities can borrow from the debt markets until they can’t. Don’t become America’s first “Greece.”
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Resident Muniland expert
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