Relax and unwind

Last month, regulators announced they were extending by two years the effective date of the Volcker Rule, which was supposed to go into effect in July. This is good news for the municipal market, which otherwise would have seen some concentrated selling-off activity during the first half of this year.

The Volcker Rule, finalized in late 2013, limits banks' investments in hedge funds and other high risk vehicles, including what are called Tender Option Bonds, or TOBs. These bonds represent a small fraction of the municipal market (about $90 billion of the $3.7 trillion market) and are used to cover long term investments.

Banks and hedge funds get cash from a money market fund (a short term borrow) then turn around and invest that in a municipal bond. Because short term borrowing has typically yielded very low interest rates while rates on longer-term bonds has been higher, banks hope to pocket the difference between the two rates as profit.

Without the delay, managers would have had to unwind up to $90 billion in bonds currently held in TOB trusts during the first half of the year, which is equivalent to 60 percent of the expected $150 billion of new issuance in that same period, according to a Jan. 26 analysis by Moody’s Investors Service. “Postponement of that liquidation relieves pressure on the overall market,” Moody’s added.

Take a hint

This week I wrote about whether or not Atlantic City is heading toward bankruptcy. A key development as of late has been the state of New Jersey’s swift change toward helping its municipalities. After Gov. Chris Christie appointed an emergency management team with ties to Detroit’s bankruptcy, and gave them the direction to consider municipal restructuring, Atlantic City was slapped with a super downgrade by credit agencies. Up until this month, New Jersey had a reputation for financially helping its struggling cities. This tactical change also sends a message to the state’s other distressed cities. The state is likely to continue supporting municipalities experiencing moderate fiscal challenges,” warned a Moody’s analysis. “But, the appointment of an emergency manager in Atlantic City suggests that when credit pressures become too extreme, state support may not be forthcoming.”

Specifically, Moody’s named Harrison (Town), Paterson, Newark, Union City, Trenton and Camden as localities that needed to take notice of New Jersey’s treatment of Atlantic City. Collectively, those six cities received about $100 million in state aid in 2014 alone and most have depleted or nearly depleted fund balances. Despite the state’s strong history of support, this latest development is somewhat understandable as New Jersey’s evolving stance comes amid the backdrop of its own fiscal challenges. Those challenges are primarily pressures from recurring revenue shortfalls, weakened liquidity and surging unfunded pension liabilities.

When is it an unhealthy dependence?

A report this week by Standard and Poor’s contained a warning to oil producing states. While most have ample reserves to cover periodic downturns in oil prices, their “credit quality is likely not immune to a long-term slide in oil prices.” If such a slide happens, their credit rating will largely depend on the fiscal management response of these states, the report said. Specifically, S&P is looking at:

  • What oil price and production level did the state assume in its budget?
  • How much does the state's operating budget rely on oil-related tax revenue?
  • Did the state use prior period of high oil prices to accumulate reserves?

No oil states are triggering concerns yet. Alaska’s $3.5 billion budget gap this year is more than covered by the state’s budget reserves and investment earnings. Texas, which is the nation's largest producer of crude oil and natural gas, has estimated oil revenues based on an $80-per-barrel price -- nearly twice the current price of West Texas Intermediate oil. But the state’s diverse economy and the fact that oil production taxes comprise only 4.8 percent of general revenues in the budget are keeping its outlook healthy. The report, available to subscribers, also contains diagnoses for North Dakota, Louisiana, Mississippi, Montana, New Mexico, Oklahoma and Wyoming.