MuniLand

New analytical tools for muniland

Some great new tools have arrived in muniland that begin to stretch the boundaries of how we organize and process our endless information. Staying on top of 80,000 municipal issuers, 50 states and unlimited private activity issuers is no easy task. Check out some of the new arrivals:

Standard & Poor’s

Standard & Poor’s Ratings Services announced the launch of a free interactive web application that gives muniland participants the ability to create and compare credit scenarios. Users can model different capital structures and see possible ratings based on Standard & Poor’s general obligation ratings framework and their own data inputs. This web app follows last year’s launch of the iPad-based S&P U.S. Local Governments Credit Scenario Builder. Log on and have fun. The Bond Buyer lays out some specs:

The app includes the seven criteria Standard & Poor’s uses to assign a credit to a municipality: economy, management, budgetary flexibility, budgetary performance, liquidity, debt and contingent liability, and institutional framework.

If a user has some data about a local government based on a previous agency report or from financial documents, he or she can duplicate the rating and then project how it might change under certain conditions. The app produces ratings in all lowercase letters to distinguish it from real Standard and Poor’s ratings, which are given in uppercase letters.

By clicking on the economy tab, for example, users can adjust the per capita income to indicate a thriving economy or a struggling one. By clicking on the liquidity tab, they can adjust the amount of cash available to the government as a percentage of its debt service. Users can name and save their scenarios and compare them with one another to see how events like a major expenditure of cash reserves might move a local government’s credit rating.

Muniland’s multi-purpose plumbing

 

There has been a lot of reporting about the more than 90 retail-size trades made in the $3.5 billion Puerto Rico general obligation bond that was issued March 11. The official statement for the deal says that transactions may not be done in amounts below $100,000 unless Puerto Rico is raised to investment-grade from junk.

I’m not sure if dealers were knowingly breaking the rules, too lazy to read the bond’s documents or thought that regulators would not be paying attention when they executed the trades. It could have been small regional dealers executing the illegal trades or maybe even the brokerage operation of one of the underwriters. Dealer identities on trades are never made public, so there is no way of knowing.

The risks of municipal default and bond insurance: Part 2

When I put up a post about bond insurance and default rates last week, I expected pushback from proponents of municipal insurance. I got some.

Events in the last seven years show anecdotal evidence for and against municipal bond insurance. The bankruptcies of Jefferson County and Detroit and the workout of Harrisburg, Pennsylvania demonstrate the value of a bond insurer that makes full interest and principal payments for defaulted bonds. Investors undoubtedly benefit from this continuity of payments.

In contrast, we have the financial collapse of 2008, when most bond insurers were downgraded below the level of the issuers they had insured. The issuers started trading on their underlying ratings, and as far as I know, they were not refunded for the insurance premiums they had paid upfront. In a big financial crisis, bond insurance is a bust.

Don’t let Chicago’s crisis go to waste

Moody’s cracked the whip and downgraded the rating of Chicago’s general obligation bonds to Baa1 from A3 this week. It’s only a one-notch downgrade, but no American city should wear the scarlet letter of BBB. Chicago’s Mayor Rahm Emanuel is seemingly frozen in place and having a tough time addressing the city’s fiscal problems. His behavior belies his famous 2009 quip to never let a serious crisis go to waste.

Moody’s in its rating comment about the city’s $8.3 billion general obligation and sales tax debt seems to think Chicago is in pretty rough shape:

The negative outlook reflects our expectation that, absent a commitment to significantly increase revenue and/or materially restructure accrued pension liabilities to reduce costs, the city’s credit quality will likely weaken. The formidable legal and political barriers to these actions are incorporated in the outlook.

Where did all the bonds go?

Long-term municipal bond issuance is shrinking. I don’t need to recite the numbers, just look at the chart above (from Sifma with data from Thomson Reuters).

Municipal tax-exempt bond issuance has been lower than 2008-levels for five years. I wrote last August:

There are many factors that are weighing on issuance, but the primary one is likely to be the higher rate environment. There are other factors like shrinking federal revenues due to sequestration and rising pension and healthcare costs for state and local governments. There has been more active pressure from rating agencies about future liabilities like pensions and a lot of uncertainty about the direction that Congress will take regarding capping the muni bond tax exemption.

Will Puerto Rico sell general obligation bonds?

The New York Times reported that Morgan Stanley is shopping a potential $2 billion general obligation bond deal for Puerto Rico. Bloomberg followed up with a story that had a few more details about the offering that Puerto Rico supposedly has not authorized. According to Bloomberg the possible deal terms are:

The taxable general-obligation deal said to be under discussion would have maturities of at least five to seven years. The funds [hedge funds and distressed debt buyers] would assist the commonwealth as it struggles to turn around its shrinking economy. The discussions have cited possible yields of about 10 percent, the people said.

Let’s break this proposed issue into several pieces:

Taxable: Issuing taxable municipal bonds makes sense because it attracts a broader base of investors (including hedge funds, commercial banks and some insurance firms) outside of muniland that don’t take advantage of the municipal bond tax exemption. But the extremely high interest rate is a signal to any bond investor that the security has very high risk, regardless of its investment-grade rating from the three major raters. So we can rule out banks and insurance companies as buyers.

How much do mutual fund flows affect the muniland yield curve?

Municipal bond yields rocketed up late last May after Federal Reserve Chairman Ben Bernanke commented on the likelihood of quantitative easing being drawn back at the year’s end. Mutual fund investors, spooked by possible losses from rate increases, began exiting muni funds.

S&P Indices does a good job of aggregating yields for all maturities and credit qualities (i.e. 5, 10, 20 and 30 year bonds rated AAA, AA, A, BBB). But a even rich index like S&P doesn’t show us some of the finer movements of the market.

Thomson Reuters Municipal Market Data plotted AAA general obligation bonds maturing in 5, 10, 20 and 30 years. This gives us a more precise picture of yield movements across the interest rate curve over time. You can see the same yield spike that happened in late May and early June in the S&P index.

Selling Puerto Rico Cofina 3.0

 

Richard Larkin is generally positive on Puerto Rico. Larkin is Senior Vice President and Director of Credit Analysis at H.J. Sims. At the Bloomberg Muni Link conference last November, Larkin thought the interest rate that Puerto Rico would have to pay to sell a third lien of its Sales Use Tax bonds (known as SUT bonds or Cofina 3.0) would be around 7 percent. This was pretty much in line with market chatter.

A muniland outlook for 2014

After taking a look back at 2013, here are my predictions for muniland in 2014.

The biggest muniland story this year will be the development of the Chinese municipal bond market. It’s not often that you get to watch a government launch a bond market. And China’s will be massive. From the South China Morning Post:

The [Chinese] mainland’s quest to solve its $3 trillion-and-growing public debt problem by starting a domestic municipal bond market hinges on the one thing officials are most afraid of: transparency.

As markets absorb the results of the latest audit of state finances, Beijing’s long-standing vow to develop a municipal bond market to curtail rapid growth in other types of hidden public debt will take centre stage once more.

Muniland’s ‘Best of 2013’

Some exciting developments happened in muniland in 2013. Here is a round-up:

Best paradigm shift

The Center for State and Local Government Excellence developed a holistic approach to analyzing pension costs for local taxpayers that eschews the current approach of reporting municipal, sewer, library and school pension burdens separately.

The team at The Center for State and Local Government Excellence has set a new standard in how local pension burdens should be reported in financial documents like CAFRs. The center’s new approach for measuring a municipality’s pension burden is to aggregate the direct cost of locally-administered pension plans (both city and taxpayers’ share of costs) and contributions to state teacher and non-teacher plans on behalf of dependent school districts. The aggregated cost is compared to a community’s revenues to understand how much must support pensions.

A lot of previous pension analysis looked at pension plans’ funding levels. This study looks at the cost to taxpayers to support the pension promises they have made.

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