MuniLand

Who is earning tax-exempt interest from muni bonds?

About one third of the U.S. House of Representatives signed a letter to keep the current tax exemption for municipal bonds in place. Investment News got the story:

The municipal bond market’s dogged efforts to prevent President Barack Obama from tinkering with the 100-year-old tax exemption for muni bond income has received some high-profile support from 137 members of Congress.

A letter supporting the status quo for the muni tax exemption, and signed by 95 Democrats and 45 Republicans, was delivered today to Speaker of the House John Boehner and minority leader Nancy Pelosi.

No comparable letter of support has circulated out of the Senate. The question of capping the tax exemption for municipal bonds at 28 percent has been bouncing around for about two years. Here is the latest IRS data (from 2010) that shows the number of tax-exempt filers by income category:

 

In 2010 there were 5.95 million taxpayers who filed claims that included tax-exempt interest. The total amount of deductions was $72 billion, or an average of $12,105 per taxpayer. However, the average is misleading. In the lowest income bracket ($1-$5,000), taxpayers claimed an average of $2,631 of tax-exempt interest. In the highest income bracket (above $10 million) the average tax-exempt interest claim was $486,387 per taxpayer.

Muniland gets a data boost

The Federal Reserve Bank of New York has begun publishing data about the bond holdings of its primary dealers. Primary dealers are the largest and most active trading groups in bond markets. This new data will add a lot to our understanding of market flows.

The primary dealer banks own less half than 1 percent of outstanding municipal bonds, or $17 billion for the week ending June 19, 2013. The amount of municipal bonds outstanding is $3.7 trillion.

According to MSRB’s EMMA data system, the average daily trade volume by par amount for the last thirty days for municipal bonds is $12 billion. Dealers are holding about 1.4 days’ worth of trading volume. The big dealers traded $8.8 billion of securities for the week of June 19, controlling about 73 percent of daily muniland trading.

It may get easier for retail investors to buy bonds

Muniland’s oversight organization, the Municipal Securities Rulemaking Board, has proposed some new rules to the SEC that may make it easier for retail investors to buy bonds that are newly brought to market.

The dealers who underwrite bond offerings tend to favor their institutional and high net worth clients, so typically retail investors have a difficult time getting an early part of the pie. In fact, the issuer would often prefer that their bonds be placed with retail investors, because they tend to be the most stable owners as buy-and-hold investors.

The MSRB’s new measures would strengthen the retail order period. The first would establish specific obligations on the senior syndicate manager to disseminate detailed information about the terms and conditions of any retail order period. Whatever terms the state or local government has set for retail investors to be able to buy bonds must be provided to all the dealers in the selling group (on a large deal this could be up to 15 or more dealers). It sounds simple, but it doesn’t always happen.

The high cost of borrowing for Illinois

Illinois, the state with the lowest credit in the United States, had to pay up this week to bring a $1.3 billion general obligation bond offering to market. Reuters reported that the general obligation bonds due in 25 years were priced at 5.65 percent on Wednesday. This was approximately 180 basis points (1.80 percent) over Thomson Reuters MMD AAA, compared to a spread of 138 basis points on Tuesday. In other words, Illinois got spanked hard.

Illinois has massively unfunded public pensions and a huge stack of unpaid bills that make the state less creditworthy and force it to pay higher interest rates when it borrows. But a new study by the Mercatus Center suggests that, since the risk of default for Illinois is very small, the state is overpaying for its bond offerings. The study’s author, Marc Joffe, formerly a Senior Director at Moody’s Analytics, developed a fiscal simulation model that takes into account pension, education and health care payments over time in addition to debt service:

In a bond market massacre, liquid products win

It comes as no surprise to those who understand markets that the less liquid a product is, the more its price will decline in a fast market rout. This has happened over the last few days in the municipal bond market.

The buying and selling of individual municipal bonds can be especially illiquid for retail investors because they don’t have much real-time market data. More importantly, they face very steep transaction costs, or markups, that dealers put on bonds sold in small lots. I wrote about this last week:

Securities and Litigation Consulting Group of Fairfax, Virginia, recently published a report that analyzed almost $3.7 trillion worth of municipal bond trades that happened between 2005 and 2013 (page 8). SLCG found that the median markup for a trade up to $25,000 in size is 1.79 percent.

Is there such a thing as a ‘fair’ markup in muniland?

It’s well known in muniland that retail investors, who buy smaller lots of bonds than institutional buyers, get hit with high markups. The rule is that dealers must deal “fairly” with investors. Translation: Markups to customers cannot exceed 5 percent. So if a dealer sells a bond worth $5,000, he may not charge the client more than a $250 markup. However, there is no regulatory requirement for the dealer to tell the client how much the bond has been marked up; just that it was marked up. Many believe these differences in bond prices are excessive, but no one has figured out a way to reduce or stop the practice.

Securities and Litigation Consulting Group of Fairfax, Virginia, recently published a report that analyzed almost $3.7 trillion worth of municipal bond trades that happened between 2005 and 2013 (page 8):

SLCG found that the median markup for a trade up to $25,000 in size is 1.79 percent. Here is an example of a trade with an excessive markup, from page 11 of the study:

Puerto Rico’s new budget

Puerto Rico’s governor Alejandro Garcia Padilla presented his new budget for the Commonwealth on Thursday. Caribbean Business reported on the details:

Puerto Rico Gov. Alejandro García Padilla unveiled a $9.83 billion operating budget Thursday night during a state of the commonwealth address in which he pledged to reduce crime, create jobs, boost school attendance and expand the U.S. territory’s tourism sector.

The proposed spending package is $783 million more than the current budget, which will be covered by new revenue and $200 million in deficit financing, he said.

Gallagher’s muniland armageddon

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Several professionals in muniland have jumped on SEC Commissioner Dan Gallagher for his recent warnings about the possibility of an “Armageddon” for retail investors in muniland.

Anonymous blogger @munilass berates Gallagher for his statements about retail investors:

In the interview, Gallagher said his concerns mostly relate to retail investors, who hold approximately three-quarters of outstanding municipal bonds. He then called the muni market a bubble (a term that becomes less useful every time someone utters it) and said “there are a lot of investors in the municipal bond market that aren’t supposed to be there.”  I take the latter to be a reference to credit risk, not interest rate risk, but Gallagher did not elaborate, so I am not sure what he meant by that.

Muniland has a disclosure problem

There is a glaring gap in regulation – called Regulation Fair Disclosure – when it comes to protecting municipal bond investors. It appears that issuers may be in the habit of giving material nonpublic information to preferred institutional investors, while making retail and non-preferred investors sit out in the cold. Exhibit number one is the treatment of media members who have petitioned to attend the City of Philadelphia bond investor day scheduled for this Thursday. The Philadelphia Inquirer wrote:

Several news organizations led by Bloomberg News are protesting the exclusion of the news media from a two-day conference sponsored by the Nutter administration to stimulate investor interest in the city’s municipal bonds.

The Inquirer has joined the protest, signing a letter to Nutter that criticizes the city for refusing to let reporters attend the conference, scheduled to begin Thursday at the Comcast Center.

Distress in muniland

The Bond Buyer is holding its 2nd Annual Symposium on Distressed Municipalities in Providence, Rhode Island on March 18-19. Though I am not there, some conference attendees have done a great job of tweeting the highlights. Here is a selection as the conference continues into its second day:

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