MuniLand

2.5 million muni bond investors unaffected by proposed tax changes

In his budget for fiscal year 2013, President Obama has resurfaced his proposal from last September to reduce the tax exemption for the wealthiest municipal bond investors. This tax reform proposal is unlikely to pass this year, but a battle is already raging in the media about what damage the change could do. Dire predictions of much higher yields for municipal bond issuers are being thrown around with little or no verification.

Even if this proposal did pass this year, muniland would not be disrupted. In fact I think it could democratize the municipal bond market in a big way. There are more than 2.5 million investors who own municipal bonds and would be unaffected by the proposal. It’s true that yields could rise a bit as the wealthiest investors exit the market, but this would just make muniland more attractive for the less affluent, since they would still be able to utilize their tax exemption. Rich investors would lose, but middle- and low-income municipal bond investors would gain.

Here are the specifics of the proposal from Market News International:

The administration is proposing to “reduce the value of itemized deductions and other tax preferences to 28% for families with incomes over $250,000.”

“Currently, a millionaire who contributes to charity or deducts a dollar of mortgage interest, enjoys a deduction that is more than twice as generous as that for a middle-class family,” the FY 2013 budget proposal reads.

“The proposal would limit the tax rate at which high-income taxpayers can reduce their tax liability to a maximum of 28%, affecting only married taxpayers filing a joint return with income over $250,000 (at 2009 levels) and single taxpayers with income over $200,000,” it continued.

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.

Muniland’s public officials are clueless, not corrupt

Matt Taibbi’s latest piece for Rolling Stone, “How Banks Cheat Taxpayers,” blasts a common municipal bond market practice in which a state or municipality selects an underwriter for an offering without soliciting competitive bids for the project. These are called “negotiated bond offerings” in muniland parlance, and Taibbi likens them to a legalized form of bribery:

By “negotiated underwriting,” what Bloomberg means is, “local governments just hand the bid over to the bank that tosses enough combined hard and soft money at the right politicians.”

I really hope that Taibbi’s is making a hyperbolic statement to draw attention to his main premise that new bond offerings should done on a competitive basis, with which I agree entirely. But he implies that all state and local politicians are standing around with their hands out and are actively being bribed by Wall Street banks. If our country is that corrupt, we are in for a lot of trouble.

Munis are the star performer of 2011

Bloomberg had a great piece that rounds up the factors that made municipal bonds the best performing financial asset of the past year. The story is framed as a knock on Meredith Whitney for her scare call a year ago:

This was supposed to be the year the $3.7 trillion state and local debt market would be rocked by an exploding pension time bomb and “hundreds of billions of dollars” of defaults, according to analyst Meredith Whitney.

Whitney’s Armageddon never came. Instead, munis became the star performers of 2011.

Found: $840 billion in municipal bonds

The Federal Reserve has quietly admitted they had undercounted about $840 billion of municipal bonds. Bloomberg reports on this new pile of assets:

The U.S. municipal-bond market is 28 percent larger than reported in June, according to a quarterly Federal Reserve release, which used new data showing individuals own more state and local-government debt.

[...]

“The estimate of household holdings of municipal securities and loans is revised up by about $840 billion, on average, from 2004 forward,” according to the Fed’s Flow of Funds Accounts report for the third quarter.

A drought of municipal bond issuance

All year long, muniland has been dragging its feet on issuing bonds. Budgets have been much too constrained to take advantage of historically low interest rates. At the end of the third quarter of 2011 issuance was 39 percent lower than 2010, according to Thomson Reuters SDC data. Nine-month issuance for 2011 was $160 billion versus $262 billion for the same period last year.

It’s a veritable drought.

What do muniland insiders think?

When the mainstream press pays attention to muniland, often it’s the most colorful and misinformed voices — think Meredith Whitney – that dominate coverage. So it was great to get some interesting data today on how municipal insiders view the market from the muni team at RBC Capital Markets. They did a survey of 116 municipal market professionals at the recent Bond Buyer’s California Public Finance Conference. Respondents included officials from federal, local and state governments; bankers; and other municipal finance professionals in attendance.

The key findings, shown in the chart above, are that industry participants worry most about the low level of bond issuance, headline risk and federal budget issues. Headline risk and federal budget problems are out of the control of everyone in the municipal space. But low issuance is a puzzler. Certainly these professionals have had their trade reduced as fewer bond issues come to market and as municipalities face harsher credit constraints than they are used to.

Another terrifying data point reported by RBC is the length of time respondents thought that it would take for state and local government revenues to return to pre-crisis levels.

The Christie discount

The Christie discount

The media is reporting that New Jersey Governor Chris Christie will announce that he is not running for the Republican presidential nomination this afternoon. That’s probably wise given that the credit markets’ opinion of New Jersey would undercut any claim candidate Christie could make to being a responsible budget manager.

If you look at the Markit municipal credit default swap chart above you can see that credit markets think that the financial condition of New Jersey is pretty bad. It ranks only behind California and Illinois as a poor credit risk. It would be very hard for Governor Christie to tell the story of his fiscal successes in his state given the data. To be a credible candidate for the presidency he needs to develop real improvement for his state and reverse the Christie discount.

Here is the real muniland story

From the blog Credit Writedowns:

US states and local governments cut their debt by 3.2% in Q2 and 4.2% in Q1. This year looks to be the first year since 1996 that local governments in the US reduced their indebtedness.

The calmest seas you will ever see

Low issuance, low defaults and low rates

For issuers, conditions are just about perfect in muniland now. Many have defered or withdrawn planned bond offerings, leading to greatly reduced supply for the year. Bloomberg estimates that 3rd quarter total issuance will be about $67 billion. This follows the $117 billion in muni securities issued in the first half of the year (data from SIFMA, Excel file link). Through Q3 Billions 2010 $ 298 2011 $ 184

Defaults have also been puttering along at very, very low rates. This is due to some creative workout solutions, like Jefferson County’s negotiations with creditors, and many instances of postponement of problems, like Collingswood, NJ. I’ve seen estimates for total defaults for the year ranging from $1.8 billion (this number included unrated bonds) to $1.1 billion. Bloomberg says:

Municipal defaults have dropped this year to about $1.1 billion, a quarter of last year’s total, according to Bank of America Merrill Lynch. Local general- obligation bonds have accounted for only 1 percent of the 2011 failures [balance is revenue or conduit bonds].

Part-time employment up in muniland

Incredible shrinking workforces

I’ve read in a few places that state and local governments were reducing the number of full-time employees and hiring more part-time workers. There is a story in the Dayton Daily News that nicely details the trend:

The data show that both the state and local Ohio governments attempted to get the work done by hiring more part-time employees. While local governments shed a little more than 11,000 full-time employees, they added almost 6,000 part-timers, a 4.6 percent increase. The state, meanwhile chopped close to 1,400 full-time workers and added 386 part-timers, a half-percent increase, according to Census data.

Ohio’s government job-shedding put it in the top third of the 50 states, although margins of error from the Census survey data make exact rankings impossible.

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