Building a new municipal bond market

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.

2) Aggregating bid and offer prices for a municipal security so all market participants can see “depth of book.”

The conundrum in bond markets is that a specific security is not continuously quoted because the security is not available for sale on a consistent basis. Bond markets do not trade like equity markets. But that has not stopped dealers from providing streaming price quotations on some bonds. At the FIX conference, the head of electronic trading for a global dealer said that it provides live streaming quotes for 5,000 to 6,000 corporate bond issues every day, but only about 1,000 of those actually trade. The dealer is still willing to quote the security if a seller emerges. We have vastly more securities in muniland, but dealers don’t have to quote the entire universe of bonds for them. A dealer might only quote California or Texas or New York bonds, for example, and another dealer might be active in only hospital bonds.

Nuclear CalPERS

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.”

San Bernardino’s coming pension brawl

The bankrupt cities San Bernardino and Stockton, California share similar fiscal woes. Both include very high employee pay and benefits. Both have sought the protection of Chapter 9 municipal bankruptcy and are shielded by the courts from any new litigation. The court protection gives the cities time and fiscal space to negotiate with employees and creditors, and to organize their financial affairs. It’s hard to imagine the difficulty of running a city in bankruptcy with dwindling cash reserves.

Stockton and San Bernardino have taken very different approaches to how they will manage their cash reserves. Each approach will likely have big effects on how their bankruptcy processes play out.

Stockton has chosen not to challenge CalPERS, the statewide pension system, and has continued to pay the monthly pension contribution for its employees. The city’s unwillingness to ask CalPERS to negotiate has caused other Stockton creditors – the bond insurers – to challenge whether the city has met the conditions of a Chapter 9 bankruptcy. The blog Public Sector Inc describes the situation:

Bill Lockyer’s big stick

I wish that I knew how to put on a conference, because we need a muniland event with Bill Lockyer, California’s state treasurer, as the headliner. I would invite all the state treasurers and attorneys general to learn how state officials can wield their power to protect local governments from unscrupulous underwriters, bond counsels and financial advisors.

Here is Lockyer at The Bond Buyer conference in California:

Treasurer Bill Lockyer put underwriters, advisors and bond counsel on notice Wednesday that if they are not willing to renegotiate some of what he called the more egregious capital-appreciation bonds issued by the state’s school districts, his office may cut them off.

“I wish the firms that underwrote those bonds would renegotiate those deals,” Lockyer said. “I have the list, I know the underwriters, financial advisors and bond counsel who did them, and they are going to face constraints with my office when the state issues bonds.”

The 30,000-foot view of muniland

The Bond Dealers of America, an organization representing national middle-market bond dealers, held its national conference in Chicago last week. I did not attend, unfortunately, but the agenda was a good mix of regulatory and legislative perspectives from the buy-side (mutual funds, insurance firms, asset managers) and electronic trading platform executives.

What interested me most was a presentation by Amy Laskey, managing director of the Public Finance Group at Fitch Ratings, who provided a 30,000 foot view of the current state of muniland. These are the best sections that present a mixed-to-positive picture:

Review of Recent Rating Actions

• Average local government general obligation rating remains ‘AA’ but trending towards ‘AA-’

Broke New York municipalities have more choices than bailouts or bankruptcy

Things are heating up in Albany, New York’s capitol. Someone close to Governor Andrew Cuomo appears to have been whispering into the ear of New York Post reporter Fredric Dicker:

Several of New York’s biggest cities — including Yonkers, Rochester and Syracuse — are “close to bankruptcy’’ and are looking for a bailout from Gov. Cuomo’s administration, The Post has learned.

Mayors of the three cities, all of which face runaway labor, pension and education costs and shrinking property-tax bases, have held secret talks in recent weeks on their financial options, and the possibility of “bankruptcy’’ has been discussed, a source close to the mayors said.

Lawmakers and the municipal bond tax exemption

The Joint Committee on Taxation is circulating an analysis of tax reform proposals, one of which includes removing the municipal bond tax exemption for all bonds issued after December 31, 2012. If the tax exemption is repealed or capped so that the federal government can collect more tax revenue, bond prices will fall. The higher yields would repay investors for their loss of tax exemption, nevertheless, groups are forming to oppose proposals to repeal the exemption.

Republican presidential candidate Mitt Romney has not indicated any specifics about how he would treat muniland in his tax reforms. President Obama has proposed changes. The Bond Buyer summed up the President’s position:

Some market participants contend that Obama’s plans to raise tax rates and permanently reinstate the Build America Bond program would help the muni market, despite his plan to cap the value of tax-exemption at 28% for higher income earners.

Danville’s AAA disclosure

One of the most common complaints in muniland is over a lack of disclosure. Public officials often say too little too late about fiscal matters. That is why it was a pleasant surprise to come across the proactive response of Joseph Calabrigo, the town manager of Danville, California, to Moody’s announcement that it is reviewing credit ratings associated with lease-backed and/or general obligation debts issued by 32 cities in California.

Danville is a well-to-do town of 42,000 located about 30 miles east of San Francisco. The city has two sets of bonds outstanding that are included in the Moody’s review. These Certificates of Participation (COP) were issued  to acquire and construct public parking in the downtown area. In speaking about it, Calabrigo was separating the review of these bonds from the general credit quality of Danville, which is one notch higher at Aa1.

From the Danville town blog:

Danville has an overall credit rating of Aa1, as assigned by Moody’s.  This rating shows a strong credit profile and overall creditworthiness. The Town’s current Aa1 rating is not under review by Moody’s.

Puerto Rico’s pain stretches to its lack of assets

Juan Carlos Batlle, President of the Government Development Bank for Puerto Rico, does not like the way I characterized his comments at the Bloomberg State & Municipal Finance Conference last week.  Here is the transcript of the panel he appeared on, so you can read his comments for yourself.

My criticism of Mr. Batlle was that the citizens of Puerto Rico were getting very little benefit from the government’s auction of a 40 year concession to the Luis Munoz Marin International Airport (LMM). But as I delved further, the situation became much more troubling than I had thought. It appears that Mr. Batlle and Puerto Rico are desperate to raise funds to pay down their massive debt load. Here is what Batlle said at the Bloomberg conference about leasing the LMM (from the transcript):

BATTLE [sic]: So we – for that we need to – I mean, we have I guess many people here know Puerto Rico’s situation in terms of her high debt load. So we have to tackle the issue and we have to start lowering our debt load.

CDS in muniland – There is no “there” there


Kamakura Corporation, a risk management firm in Honolulu, Hawaii, has updated their analysis of the volume of trading in municipal credit default swaps (CDS). Here is what they say:

On January 11, 2012, we looked at weekly credit default swap trading volume for subsovereigns and municipals among 1,090 90 reference names that had traded in the 77 weeks ended December 30, 2011.  We found, unfortunately, that (in the words of Gertrude Stein) “there is no there there.” In this blog,  we update our CDS volume analysis for subsovereigns and municipals for the 103 weeks ended June 29, 2012. Alas, our conclusion is unchanged.

Kamakura documents that there is very little volume in muni CDS trading, and most of it is done between dealers. Essentially it’s an artificial market with very few trades outside the dealer community.  Kamakura, in their analysis, strips away the trades that dealers are doing between themselves:

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