The Muni Bond Market in 2013
Issuers may be enjoying low-interest rates when they come to market, but that doesn't mean these are the best of times.
In the good old days, the municipal bond market was disparaged as the "queen dowager" -- too stiff and tradition-bound to keep up with the times. Underwriters referred to it as a place where no exciting action took place. The old-fashioned market place was a quiet backwater where governments and their agencies could keep a low profile and go about the business of financing their projects without finding their names or their bonds in the newspapers.
Since 2010, however, the market has been roiled by predictions of issuer bankruptcy (and forecasts in the media that such bankruptcies would be prolific), by a sudden but steady withdrawal of investor money from muni bond mutual funds and now, by threats to the tax-exempt status of most muni bonds. Calls for tax-expenditure reform as part of a balanced budget deal are being pushed on both sides of the aisle. "While we can't predict the outcome of the debates," says Chris Mauro, director of municipal research for RBC Capital Markets, "we can say with almost 100 percent confidence that the headline risk in the municipal market remains high and is destined to become even more acute over the next two months as we approach the upcoming fiscal battles."
Despite those travails, Mauro predicts that state and local issuers will come to market with $325 billion in bonds (although he concedes that his numbers are comparatively low among Wall Street forecasters). In breaking down that volume between new money and refunding, he says new money issuance will be up about 10 percent over last year at $285 billion. "We're still in an environment of austerity on the part of state and local governments, but there is some pent up demand." The new money estimates are good news in that new investment translates into jobs. Refundings, on the other hand, will be down. "Bonds that would have been refunding candidates in 2013 were in fact taken out by deals last year," Mauro says. "The current candidates pool is smaller than what most people believe. Refundings will be down by about 12 percent."
Also of note this year, redemptions of muni bonds -- that is, the calling in of bonds by issuers -- will be up in the first half of this year, according to Mauro. He expects "to see redemptions exceeding supply," but that's only for the first half of the year.
On the darker side, Allan Sloan, senior editor-at-large for Fortune magazine, is warning about a muni bond bubble. "Thanks to the Federal Reserve's holding down interest rates and the prospect of steeper income taxes facing top-bracket types," he wrote in December, "high-grade munis, which pay tax-free interest, have become insanely popular. And are a train wreck waiting to happen."
There's also risk ahead with bond credit ratings. The credit rating agencies will be reconsidering many a rating based on new accounting rules for assessing pension plan liabilities. Rule changes by the Governmental Accounting Standards Board will require that pension funds make more conservative investment projections and disclose liabilities more clearly. These proposed changes are likely to lead to reductions in credit ratings for many governments and that would, of course, lead to higher borrowing costs or reduced access to loans. Overall, the rule changes will increase by large numbers most governments' reported debt and pension expense.
Experts on benefits and compensation note that the main importance of these imminent changes is that they help explain how unfunded pensions produce much greater risk and by implication what to do about it. They agree that the impact of the changes will be profound.
On a brighter note, the Municipal Securities Rulemaking Board (MSRB) held its quarterly meeting last week and took some actions to shore up issuers' position in the marketplace. One area MSRB visited was the retail order period in which the issuer of a bond sets a timeframe for retail orders as opposed to institutional orders. MSRB's concern was that issuers need greater flexibility to define the retail order period and what the obligations are of the dealer team in terms of complying with that requirement.
"We're not looking at changes but clarity," said MSRB Chair Jay Goldstone at a press conference. "As an issuer myself, when I get a 5- to 10- to 15-page disclosure letter, is it covering what the board's intent was or just expanding beyond that? We are getting feedback from issuers as to what does it mean when you receive a notice. Am I just acknowledging receipt of a document or am I waiving rights by signing it?. We're looking at those issues to provide guidance."