The Muni Market's Bumpy Year
2006 had its ups and downs--although it was mostly positive for issuers and negative for some underwriters.
The municipal bond market was a welter of contradictions last year: The credit ratings of state and local issuers showed impressive stability and issuance was steady--even as bond underwriters found themselves in the roiling waters of a massive federal investigation.
In November, the Federal Bureau of Investigation raided the offices of three guaranteed investment contract brokerage firms, amid allegations that the companies have been manipulating municipal bond yields and failing to pay required rebates to the federal government.
In addition, the U.S. Justice Department is looking into wider- ranging malfeasance in the muni market, issuing subpoenas to many major Wall Street investment banks, while the Securities and Exchange Commission is conducting a related civil investigation. Those investigations, which are scrutinizing deals going back more than a decade, are continuing this year.
Some state and local issuers responded to the FBI, DOJ and SEC concerns by either delaying deals or demanding disclosure of audits and subpoenas from affected firms.
Other 2006 changes were more benign. The Bond Market Association, which represents the interest of municipal as well as other government and corporate bond dealers, and the Securities Industry Association merged, creating a new industry group called the Securities Industry and Financial Markets Association. The New York Stock Exchange and NASD also announced plans to create a new organization with broad regulatory responsibilities, including overseeing muni bond underwriters.
On the regulatory side, the federal Tax Increase Prevention and Reconciliation Act, which included new regulations for pooled-bond issuers, went into effect in May. Those new rules mandate, among other things, that pooled issuers spend 30 percent of their bond proceeds within a year.
None of these developments, however, call into question a simple fact: 2006 was a good year for issuers. No state saw its general- obligation bond credit ratings downgraded, while a handful of states enjoyed upgrades. Credit rating agencies have been upbeat, thanks to the health of state and local government revenues. Coffers in many states have been buoyed by rapidly growing corporate income tax revenue, while many local governments have enjoyed record property tax receipts.
State and local governments issued $383.4 billion in bonds in 2006, the second highest figure on record, behind only 2005. The small decline over the previous year is entirely attributable to a reduction in refundings. Most issuers that were in a position to refund took advantage of low interest rates in 2005 to do so, leading to the drop in 2006. But even as refundings declined, the value of new-money municipal bond deals actually increased.
Next year's outlook remains relatively rosy, with revenue forecasts still strong and interest rates expected to stay in check. "The one uncertainty is the housing situation," says Steven Davidson, vice president and director of research for SIFMA. "The view is that there's still part of the housing correction that needs to be worked through." But the cooling housing market hasn't cut into the revenues or credit ratings of most governments yet, in part because assessments tend to lag behind real estate values.