MuniLand

Bond issuance is declining in muniland

Thomson Reuters

There has been plenty of analysis about declining muniland bond issuance at the gross level, but very little diving down into more specific monthly data. MSRB’s EMMA platform provides the data for parsing.

When looking at 2011 data it is important to remember that the Build America Bond program expired December 31, 2010 (taxable municipal bonds that carried special tax credits and federal subsidies for either the bond issuer or the bondholder). BABs had drawn a lot of municipal issuance forward into 2010 that might normally have been done in 2011.

The overall number of new bond issues per month has declined for the last three years. Issuers refunding their bonds to get a lower interest rate increased in the first quarter of 2013 and then declined in the first quarter of 2014 (see chart above):

EMMA

The average dollar size of bond issues appears to be getting slightly larger for most months, but some distortion could come from individual bond issues like the March 2014 $3.5 billion Puerto Rico general obligation bond offering:

EMMA

The total dollar amount of bonds issued has declined every month:

EMMA

All market analysts that I have seen predict less than $300 billion of new issuance for 2014. All muniland issuance data points are in decline.

Visualizing muniland

If you are an investor, an analyst or a taxpayer, finding information about the outstanding debt for a state or a city is a mixed lot. Some issuers, like New York City and Connecticut, do an excellent job of providing information. Massachusetts remains the gold standard. Many other issuers though have out-of-date and incomplete information.

New York City graphs general obligation debt principal and interest repayment. The city has a repayment schedule and $41.9 billion of GO debt outstanding.

NYC

Illinois has daily cash tracker that shows how much has come in and gone out of the general fund (with $156 billion in overall debt outstanding):

Muniland will keep shrinking

Thomson Reuters

One of muniland’s most accurate forecasters, Tom Kozlik of Janney Capital Markets, has some astonishing numbers in a new report. He predicts that total municipal bond sales for 2014 will drop to between $250 and $275 billion. That is a big fall from 2013 issuance of $330 billion. Here are some of the factors that Kozlik used to develop his rationale for a shrinking muniland:

    Higher interest rates Use of direct bank loans Austerity measures Less flexibility in spending Political and voter attitudes Lack of broad public policy supporting infrastructure spending

Kozlik goes further and says that the same factors will cause issuance to fall further in the next one-to-three years. So muniland could shrink for the next three years. Couple this with extraordinary demand for municipal bonds, and it’s an issuers’ market.

Most of Kozlik’s theory has already been dissected, but he brings in a sociopolitical angle that is not often discussed. The lack of broad public policy support for infrastructure spending is a significant issue. Reuters reported a poll in which California voters said they prefer paying down debt to broadening the social safety net.

S&P tells muni issuers to disclose bank loans

Eight out of ten times when state and local governments need to borrow money, they go to the municipal bond market. The public information repository EMMA, which is offered by the MSRB, allows anyone and everyone to assess how the borrowing affects the borrower’s capital structure and predict whether bondholders will be paid back.

But there is a growing trend of state and local government borrowing from banks for which no law says that it had to be publicized. This has left taxpayers and bondholders in the dark.

A white paper issued last year encouraged local governments to disclose when they take money from a bank. Muniland players have not followed the suggestion, and government borrowing from banks has continued to go on behind closed doors.

Knowing the best way to trade municipal bonds

For retail investors, it has always been a little murky where their municipal bond trades are executed. Municipal bonds can officially trade on the New York Stock Exchange Bonds platform, but they rarely do. Instead, almost all municipal bond trades happen over-the-counter between dealers via alternative trading platforms like Bonddesk (a part of Tradeweb that is majority-owned by Thomson Reuters) or The MuniCenter. Unlike the equity market, municipal bond brokers are not required to disclose where they execute a specific trade.

Brokers are only required to give customers “fair pricing.” They are not required to route retail orders to where they will find the best execution. The fair pricing rule requires “the dealer either will need to know the current market value of the security, or will have to use diligence in the attempt to ascertain it.” A requirement for “fair pricing” is a lower standard than “best execution.”

The Municipal Securities Rulemaking Board announced that it will seek approval for a new best execution rule that governs how broker-dealers handle retail orders for municipal bond trades.

Shrinking muniland

Muniland continues to shrink, except for one small corner, seen in the fourth chart below. The charts are from SIFMA’s US Municipal Credit Report, First Quarter 2014:

There is one corner of the municipal market that is increasing in size — bank loans to state and local governments. I wrote previously about the estimates that Standard & Poor’s has made on the bank loans that municipal issuers have taken out:

Standard & Poor’s recently issued a comment piece that sheds more light on the shrinking municipal issuance story. They reviewed or rated 173 direct loan municipal deals totaling about $10.4 billion from 2011 through February of this year. After seeing these deals and talking with market participants, they estimate that direct bank loans to muniland might account for as much as 20 percent of new municipal borrowing.

The Treasury wades into muniland

The U.S. Treasury Department has organized a new office to monitor the municipal bond market, along with state and local finances and public pensions. Reuters reports:

The U.S. Treasury Department is forming a unit on state and local finance to coordinate its responses to developments in the country’s $3.7 trillion municipal bond market, a Treasury spokesperson said on Thursday.

According to the spokesperson, J.P. Morgan’s Managing Director for Public Finance Northeast Region and Housing Groups Kent Hiteshew will become director of the new unit in May.

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.

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.

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