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.

Although markups are a drag for most retail customers, there was an approximately 30 percent increase in customer buys on June 24. Customer buy orders climbed to 24,897, according to MSRB data, from the 30 day average of 17,699. Although the par amount of customer buy trades on June 24 was $5.2 billion – almost the same as the 30 day average. There were more, smaller, buy orders, and this generally reflects increased retail investor activity.

Although the number of customer sell trades was only slightly higher than the thirty-day average, we saw a big increase in the par amount traded. It grew from a 30 day average of $3.4 billion to $5.4 billion on June 24. This tells us that institutions were heavy sellers. We know this from the size of the bid lists that were circulating among dealers. These are lists of securities offered for sale.

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:

Healthcare “Survivor”: Muni bondholders wait to see who makes the cut

This is a guest post from Joseph Rosenblum, the Director of Municipal Credit Research at AllianceBernstein.

To stay solvent, hospitals run a numbers game, charging high prices to patients with private insurance to offset lower payments from Medicare, Medicaid and the uninsured. Some hospitals make a nice profit; others struggle. Now hospitals are facing a game changer – the Affordable Care Act, which expands Americans’ access to medical insurance, but changes the reimbursement rules to care providers.

How will this affect hospitals’ bottom lines and their ability to pay off debt?

Muniland’s changing landscape

Want to take a 30,000-foot flyover of municipal market trading? The Municipal Securities Rulemaking Board has published its 2012 Fact Book. Let’s have a look at some of the highlights.

By every metric, municipal bond trading has been declining since the first quarter of 2008:

In the meantime, yields on municipal bonds, in lockstep with U.S. Treasury yields, have been declining since the end of 2008. Note also the separation between the customer-bought trades  (blue line) and customer-sold trades (black line). This is the difference (or spread), and it equals the revenue earned by dealers on transactions. This spread has widened since 2011.

The myths around the municipal bond tax exemption

The debate surrounding the sacred cow of municipal bond tax exemption is reaching new heights. In a recent report from the National League of Cities, estimates by SIFMA (the dealer trade group) show that municipal governments would have paid an additional $173 billion in interest over 10 years with a 28 percent cap on municipal bond tax exemption. And if Congress had fully repealed the municipal bond tax exemption, municipal issuers would have paid an additional $495 billion in interest costs over the last 10 years. These amounts would be on top of the $1.09 trillion in interest paid on municipal bonds in the last 10 years under the current law.

SIFMA/NCL arrived at these projections using this method (page 6-7) emphasis mine:

The information in Chart C was determined by taking the amount of interest paid by each jurisdiction in the last fiscal year, with a median interest average of 4.69 percent over the past 15 years (Thomson Reuters), and applying a 70 BPS increase for what the interest costs would have been if the bonds were issued with a cap in place, and applying a 200 BPS increase for what the interest costs would have been if the bonds were issued without the exemption in place.

Massachusetts creates the gold standard for municipal bond disclosure

Here is the hottest thing in muniland disclosure right now:

The Commonwealth of Massachusetts has poured a lot of effort and creativity into figuring out how to keep its bond investors up to date with financial data. Today it consolidates lots of municipal bond data in one place. It’s a muniland “one stop shop,” and I hope it inspires other states and municipalities to improve their games on disclosure.

In an email, Colin MacNaught, the debt manager for Massachusetts, wrote this about the site (emphasis mine):

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