The Muni Market in 2012
Economists and analysts are optimistic this year will be better than the last. Still, there are a few storm clouds on the horizon.
The $3 trillion municipal bond market rang in the New Year with self-congratulatory huzzahs for what didn't happen. 2011 was the year that disaster was supposed to hit. It didn't (with the possible exception of the sewer bond problem in Jefferson County, Ala.). To the contrary, investors did well. Muni bonds generated an average return of about 10 percent in 2011, according to the Barclays Capital Municipal Bond Index. Issuers also fared well. The annual average 10-year borrowing cost for top-rated state and local governments ended the year at about 2 percent, a Municipal Market Advisors index found. That is the lowest rate since the firm began collecting data in 2001.
Looking ahead, market analysts are feeling pretty good about 2012. A poll of municipal bond underwriters, on what the rate of default for 2012 might be, found the median expectation is for 24 issuers to default for a par value of $3 billion. That's not a number that spells disaster.
The real story of 2011 is likely the low rates issuers had to pay to borrow money, which may have had something to do with the scarcity of new issues. Issuance in 2011 -- around $295 billion -- was the lowest it's been in a decade, down 32 percent from 2010. Issuance of general purpose debt was off the most: It went from $119.4 billion in 2010 to $85.2 billion, a fall of 29 percent. Analysts expect another year of low issuance, Rob Williams, director of fixed income and income planning at Charles Schwab, told The Bond Buyer. "No one is eager to go out and put pressure on revenue streams when the pace of recovery is not what many expected it would be at this point after a recession."
Ben Thompson, chief executive of Samson Capital Advisors, also sees states and localities focusing on tight budgets and that will, he has suggested, "reduce expectations for capital expenditures."
But there are some economists and analysts who see more issuers coming to the market in 2012. The Securities Industry and Financial Markets Association's (SIFMA) bankers predict that short- and long-term municipal issuance will increase 17.5 percent this year to $342 billion, and next year to $402 billion, which would still be below the numbers posted in 2010. The market has "an appetite for municipal bonds" despite the fiscal problems issuers face, says Leslie Norwood, associate general counsel at SIFMA. However, if the tax-exempt status of municipal bonds changes in 2012, that could dampen issuers enthusiasm and undermine growth in the market, Norwood says.
The Short List
Last year, many powerful political figures from President Obama to members of Congress talked about getting rid of -- or diminishing -- the tax exemption for muni bonds. That issue continues to loom large this year.
For those who want to see the exemption protected, their best bet is that Congress remains dysfunctional another year. Few tax experts expect Congress to get anything done. "It's going to be like 2011," Howard Gleckman, a resident fellow at the Urban-Brookings Tax Policy Center, told The Bond Buyer. "Congress is going to be spinning its wheels in the mud, only worse, with more mud and balder tires."
While wholesale tax reform may not be in the cards, tax expenditures as a means of cutting the federal budget deficit is. The muni-bond tax exemption, in particular, is on the short list. The federal liaisons to Congress from the Government Finance Officers Association and the National League of Cities have been mobilizing to take the case to Congress that the tax exemption is not a tax expenditure, that it is part of the original tax code and that it provides funding for essential infrastructure projects. The Regional Bond Dealers Association and SIFMA are also on the preserve-the-exemption lobbying case.
There's one other congressional approach taking shape. Sen. Ron Wyden, a Democrat from Oregon, and Sen. Dan Coats, a Republican from Indiana, have introduced a bill that would make all new municipal bonds a tax credit (which is taxable). That is, bondholders would get a credit toward their taxes rather than receive tax-exempt interest.
Will any of this move forward in an election year that's taking place at a time of extreme partisanship in Congress? Stay tuned.
EMMA Comes of Age
Run by the Municipal Securities Rulemaking Board, the Electronic Municipal Market Access (EMMA) system is home to muni bond issuers' official statements, continuing disclosure documents and advance refunding documents. It also offers real-time trade price information. That later function is now being tapped by the Internal Revenue Service (IRS) to determine if some muni bonds were initially offered at prices that raise questions about tax-law compliance -- and whether issuers are harvesting impermissible arbitrage from taxable investments of the bond proceeds. While underwriters are usually responsible for certifying the issue price for bonds, IRS officials suggested last year that issuers should be taking responsibility for monitoring ongoing compliance.
The IRS's EMMA program has, an IRS spokesman told The Bond Buyer recently, "an educational focus ... about how we can use that research to try to alert issuers out there who may be unaware [of how] their bonds were trading." Specifically, "the point is to enter into a dialogue with the issuer to say, 'Hey, we saw this trading dynamic going on and we'd like to give you an opportunity to explain to us what was happening that caused this result.'"
The IRS is still at work on the rollout of the program but plans to begin contacting issuers soon.