MuniLand

Alarm bells are ringing across muniland because the discussion about capping the municipal bond tax exemption at 28 percent has surfaced again. Bloomberg reports:

“If and when there is a serious attempt to make substantial reforms to the tax code, I think that there’s a risk that the [municipal bond] tax exemption could be curtailed or eliminated,” said Decker, the co-head of SIFMA’s municipal securities activities.

The possibility of municipal-bond income losing its exemption from tax is as great as any time since 1986, when major tax reform was ushered into law during the Reagan administration, said George Friedlander, Citigroup Inc. senior municipal strategist.

Municipal bonds losing their tax favored treatment “is a very real threat,” said Mike Nicholas, chief executive officer of the Bond Dealers of America.

These industry leaders are echoing concerns that have been bouncing around muniland for a year and half. But the only specific proposal made by a government official came in President Obama’s 2013 budget proposal. Reuters reported in February, 2012:

The municipal bond market is one of the smaller corners of the bond market. It is dwarfed by the U.S. Treasury, government-sponsored organizations, mortgage and corporate bond sectors. Yet, muniland is larger than the equity market, as the data above (2011 and 2012 3Q year to date) shows, and it probably has more issuers than every sector combined. Muniland is a hopping place.

Thomson Reuters released its 2012 summary of municipal bond issuance data. Here is how it looked:

US municipal bond volume in 2012 reached $366 billion, a 32 percent increase over last year, but still behind 2010′s record setting underwriting volume of $430 billion by 14.8 percent.

The SEC – the top law enforcer for muniland – has been riding the range. With 17 municipal securities enforcement actions in 2012, the SEC cops have come up with a nice collection of scalps.

The Bond Buyer held a webinar Wednesday on municipal disclosure with John Cross, who heads the SEC’s Office of Municipal Securities, Jay Goldstone, who heads the Municipal Securities Rulemaking Board and various municipal attorneys. It was an excellent summary of muniland disclosure laws, but what I found most interesting was John Cross’ discussion of the top SEC enforcement actions in muniland for 2012. Rounding up the bad guys. Here are the top four enforcement actions according to Cross:

1) The General Electric and Wells Fargo bid-rigging cases: In the case of General Electric, the U.S. Justice Department prosecuted criminal charges. Reuters reports:

Governor John Kasich of Ohio and Governor Steve Beshear of Kentucky are forming a bi-state team to research funding options to replace the 50 year-old bridge that crosses the Ohio River and connects their states. The Brent Spence Bridge carries about double the volume it was designed for on Interstate 71. It is an example of valuable U.S. infrastructure in need of replacement. The big question is where the funds will come from. AP has the story:

The two governors were joined by U.S. Transportation Secretary Ray LaHood, and all three said that charging tolls would need to be a part of any financing plan.

“Uncle Sam is not coming in on a white horse to pay for all of this. Those days don’t exist anymore,” [Kentucky governor] Beshear said. “We need to find all kinds of sources.”

In the past year, three California cities have filed for bankruptcy. This casts a pall on the bonds of other California cities, because investors wonder if they also contain buried fiscal issues. In an effort to create more transparency, a new open source ratings project was recently launched:

Responding to market concerns about municipal credit quality, the California State Treasurer’s Office has commissioned a San Jose State University economist and a government-bond research group, Public Sector Credit Solutions, to develop a default probability model for city bonds.

The “default probability model” (which is what most credit rating agencies use as a model) was created by former Moody’s executive Marc Joffe of Public Sector Credit Solutions. Here is what the California State Treasurer is hoping that it will do:

MMA’s Posner: “It’s possible that the 28% #muniland tax cap could be brought up in the lame duck but not passed”#bbmash

— Cate Long (@cate_long) November 8, 2012

At the Bloomberg Link conference on Thursday, Matt Posner, of Municipal Market Advisors, said that discussion of the municipal bond tax exemption would likely be rolled over to the next session of congress, which begins January 3. Yes, the long awaited muniland battle is upon us. Strap on your armor.

Ever since President Obama created the National Commission on Fiscal Responsibility and Reform (Simpson Bowles) in 2010, the subject of reducing or eliminating the federal tax exemption for muni bonds has been kicked around. The administration proposed, in 2011, to “reduce the value of itemized deductions and other tax preferences to 28% for families with incomes over $250,000.” Muniland’s tax exemption has a big fat target on its back.

Revel casino weathers storm, credit health remains in doubt, leveraged loan down 3 pts compared to pre-Sandy $ ow.ly/eWOIu #casino

— LCD News (@lcdnews) November 1, 2012

Hurricane Sandy made landfall near Atlantic City, New Jersey, but the damage did not set back the city’s gambling and hotel economy by much. Fitch Ratings reports:

Gaming operators in Atlantic City, NJ, and across the mid-Atlantic region appear poised to re-open properties affected by Hurricane Sandy relatively quickly, limiting the storms impact on cash flow. However, Fitch believes longer term effects on physical infrastructure and consumer sentiment in New Jersey and surrounding states could have a material impact on fourth-quarter gaming demand.

I’m not a big fan of municipal bond-related mutual funds because some of their structural features work the opposite way that municipal bonds work. Mainly, the value of muni bond funds decline as interest rates rise. The WSJ.com has a useful description:

Advisers and investors appreciate being able to obtain even the current 1.8% yield from 10-year U.S. Treasurys. But many likely don’t realize the effects when interest rates rise, said James Swanson, chief investment strategist at MFS Investments. With the 10-year Treasury at a duration of about nine years, an investor faces a 9% cut to principal if interest rates rise 1% over the next 12 months and an 18% cut if rates increase 2%, he noted.

Did you catch that? If interest rates rise 1%, an investor could lose 9% of the value of his/her mutual fund. This negates one of the prime reasons to own municipal bonds for the long term:  the preservation of principle. If you are looking for the highest returns and you are willing to rotate into and out of bond funds as markets move, you might not suffer any principal loss. But that requires paying close attention to market direction and timing. Retail investors who are choosing retirement funds or putting aside cash are not generally good market timers. If an investor makes a choice and then sticks with it, the investment principal may be gone before they realize it.

When FIX – the industry electronic trading standard – was fleshed out for fixed income in 2003, municipal bonds were incorporated. I got a fresh look at FIX at the FIX Protocol Americas Trading Conference this week. All the major muniland alternative trading systems (ATS)  including Bonddesk, MuniCenter and Tradeweb, as well as the major dealers are already FIX compliant for the latest 4.4 version.

The SEC has tasked the Municipal Securities Rulemaking Board (MSRB) with several new pre-trade transparency initiatives. They are considering two projects:

1) Determining the “prevailing market price” for a municipal security.

Things are heating up in the Golden State as bankrupt San Bernardino has stopped making payments to CalPERS, California’s public employee pension system. CalPERS, of course, had something to say about it. Reuters’ Tim Reid reported:

“These [pension] payments are required to be made under California law,” Calpers said in an e-mail to Reuters. “If Calpers and the city cannot resolve the missed payments, Calpers will assert its rights and remedies available under applicable law.”

Calpers spokeswoman Amy Norris said in a telephone interview that if the payments were not made and continued to fall due, “we will pursue collection through legal action.”