MuniLand

Last December I wrote about a project sponsored by California Treasurer Bill Lockyer that is now up and running:

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.

The project is a great leap forward for presenting public data. Nothing else like it exists in muniland. Here what it contains:

A nine-member working group of banks, underwriters, financial analysts and attorneys released a white paper this week to provide guidance to states and municipalities on disclosure for bank borrowing – a small but significant sector of muniland. Since there is no requirement to disclose bank borrowings by public entities, no one knows what the total size of the sector is. I’ve heard numerous estimates in the $200 to $300 billion range, which would mean the sector is about 5.4 percent to 8 percent of the $3.7 trillion municipal bond market.

It’s pretty astounding that a community or a state has no legal responsibility to notify its citizens or bondholders when it takes a loan from a bank. Securities laws give authority to the Municipal Securities Rulemaking Board to only regulate municipal bond underwriters and not cities or states. Since a bank loan does not require a securities underwriter, the MSRB has no authority to compel disclosure. There is a lot of commentary trying to parse if and when a bank loan is actually a bond and hence subject to securities regulation. From Richards Kibbe & Orbe’s Brian Fraser and Paul Devlin:

The MSRB acknowledged that it is difficult to distinguish between loans and securities and pointed to the multi-factor test established by the U.S. Supreme Court in Reves v. Ernst & Young, Inc., 494 U.S. 56 (1990), which we discuss in more detail below. In essence, the MSRB warned the market in the September 2011 notice that there is no “one size fits all” solution to the questions posed by the loan/security distinction and emphasized that the analysis is dependent on the facts and circumstances of individual transactions. The MSRB issued its third and most recent notice on April 3, 2012. In that notice, the MSRB encouraged state and local governmental issuers to voluntarily post information about their bank loan financings on EMMA in order to promote market transparency and efficiency.

Reuters reports:

The U.S. Federal Aviation Administration signed off on Tuesday on a 40-year lease of Puerto Rico’s Luis Munoz Marin International Airport to Aerostar Airport Holdings LLC, making it the first large U.S. airport to be placed in private hands.

The deal for the Caribbean’s busiest airport, with nearly 9 million passengers a year, is a milestone in Puerto Rico’s privatization program and a bid to expand tourism to help an economy that has long been ailing.

The report is a faithful approximation of the news release, which was the result of work by former governor Luis Guillermo Fortuño. The airport privatization deal was opposed by the current governor, Alejandro Javier García Padilla and his party. When Padilla was elected, he did not support the privatization deal, but he said he would honor the contract that the former governor had signed.

In 2012, municipal debt issuance totaled $367 billion, just shy of the 10-year average ($381 billion) and a level last seen in 2003 ($378.5 billion). The blue line in the graph above shows that about 65 percent of this debt was issued to refund previously-issued debt (to get a better interest rate or other term). The balance, about 35 percent, was “new money” debt issuance to fund projects that previously had not been funded. The market sees a slight increase in issuance for 2013. According to SIFMA’s 2013 Municipal Issuance Survey, volumes are expected to be $393 billion.

New York outpaced all other states in the amount of debt issued for 2012. Of New York’s $48 billion in debt, $11.6 billion went to general obligation bonds and $36.7 billion went to revenue bonds. (See the full list of debt issuance by state on page 7 – PDF).

Here is part of a SIFMA chart that shows the amount of debt that is outstanding for each state government and the other public entities that issue debt within that state (page 13 – PDF). If you add up the “Due in 13 months” column you can get an idea of how much debt will need to be issued this year to re-issue that debt if it is not being paid off.

While everyone is focused on Washington, D.C., there is another “fiscal cliff” that is rarely discussed — the massive unfunded liabilities of state and local governments. In Puerto Rico, the worst-case of these situations was highlighted in the New York Times this week. But the story is much bigger.

Muniland is the nation’s largest employer, with 19 million workers, or 15 percent of national employment. But the tax revenues that fuel the sector have yet to recover to their pre-crisis highs of 2008. According to a new report from The States Project, a joint venture of Harvard University’s Institute of Politics, the University of Pennsylvania’s Fels Institute of Government, and the American Education Foundation (page 9):

[T]he recovery in state revenues has been slower than in previous recessions. Revenues from income tax, corporate tax and sales tax are still lower in FY 2012 by 11 percent, 18 percent, and 4 percent, respectively than in FY 2008.

The SEC is out with its second annual examination of “Nationally Recognized Statistical Rating Organizations,” otherwise known as credit rating agencies. A little known 2006 law, the Credit Rating Agency Reform Act, gave broad authority to the SEC to inspect raters as if they were broker dealers, and is what empowers the SEC to annually inspect raters. According to the law, raters must:

[M]ake certain public disclosures, make and retain certain records, furnish certain financial reports to the Commission, establish and enforce procedures to manage the handling of material non-public information, and disclose and manage conflicts of interest. The Commission’s rules also prohibit an NRSRO from having certain conflicts of interest and engaging in certain unfair, abusive, or otherwise coercive practices.

In other words raters must follow the rules, keep very good records and undergo something akin to an annual proctology exam by the SEC. Rating crimes were committed in the past and now the police are on the scene.

President Obama deserves a few mornings to sleep in, and then it is time to get back to work. Upcoming federal tax and deficit reform have been grabbing headlines, but there are other D.C. policy reforms that could have a major effect on states and cities. These need to be on the president and Congress’ 2013 checklist.

Block-grant Medicaid to the states:

Medicaid is slated to increase by approximately 17 million Americans under the Affordable Care Act for adults whose income falls below 133% of the poverty line. But who pays for this expansion? The federal government:

The Medicaid expansion is a great deal for the states. The federal government will pay 100 percent of the costs of covering people who will be “newly eligible” for Medicaid for years 2014 through 2016. These are persons who would not be eligible under their states’ current programs. After 2016, states will start paying some of these costs, but the federal government will always cover at least 90 percent.

Moody’s released a summary of its third-quarter rating actions today and the downgrade grinder continues to turn in muniland. Downgrades across U.S. public finance sectors totaled about $75 billion in the third quarter of 2012, with four issuers accounting for over 70% of the debt downgraded: The Port Authority of New York and New Jersey,  the Puerto Rico Sales Tax Financing Corporation, the Commonwealth of Pennsylvania and the Chicago O’Hare Airport Enterprise.

With the exception of heavily indebted Puerto Rico, the other three issuers are household names, and their weakening credit profile might surprise some people. Here is Moody’s rationale for downgrading the four issuers. You may start to see some patterns (emphasis mine):

Port Authority of New York and New Jersey – Consolidated bonds downgraded to Aa3/Stable from Aa2/Negative;  $18.2 billion of total debt affected.