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Wednesday, November 17, 2010 1:30 PM

Full Year of Muni Gains Wiped Out in 2 Weeks; California in Shambles, Philadelphia Downgraded; Issuance Soars; Horrid Muni Risk-Reward Setup

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A full year of municipal bond gains went up in smoke in the past two weeks. Worse yet, it's highly likely more blood is coming as issuance soars amid decreased demand from investors. A Moody's downgrade of Philadelphia, a complete mess in California, and a looming city bankruptcy in Michigan all weigh on the sector.

MUB iShares National Muni Bond Fund

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Moody's Cuts Philadelphia Bond Rating

Bloomberg reports Philadelphia Bond Rating Cut to A2 by Moody’s on Fiscal Weakness

Philadelphia’s credit rating was reduced to A2 from A1 by Moody’s Investors Service, which said the sixth most-populous U.S. city is financially weak and has limited budget options.

The downgrade, to the firm’s sixth-highest investment grade, affects $3.8 billion of general obligation bonds and similar debt. The outlook for the city of 1.5 million is stable, according to Moody’s.

Philadelphia is rated BBB by Standard & Poor’s, two steps above noninvestment grade, and A- by Fitch, four steps above noninvestment grade, according to data compiled by Bloomberg.

“The city has little budgetary margin over its five-year plan which includes significant repayment of deferred pension contributions in 2013 and 2014,” the Moody’s report says.
Realistically, Philadelphia is Bankrupt

Philadelphia is in the same big mess for the same reasons as Los Angeles, Miami, Houston, and Oakland: pension promises and public union benefits that cannot possibly be met.

It is unfair and immoral to keep raising taxes on city residents to support benefit promises that should not have been made, and cannot possibly be kept no matter how high taxes go.

Philadelphia should declare bankruptcy.

Swaps on Property and Casualty Insurers Jump on Muni Selloff

Please consider Swaps on Property and Casualty Insurers Jump on Muni Selloff
The selloff in municipal bonds is helping push the cost to protect the debt of property and casualty insurers to the highest in more than a month.

Credit-default swaps on New York-based Travelers Cos. and Chubb Corp. climbed to the highest since October. Municipal securities account for 26 percent of the financial assets of property and casualty insurers, Hans Mikkelsen, credit analyst at Bank of America Corp., wrote in a report yesterday.

“Some investors view P&C insurer CDS as hedges against muni risk,” Mikkelsen wrote. The swaps gain value as investor confidence in the companies’ ability to repay debt deteriorates.

Municipal bond prices are dropping amid a surge in issuance. Pacific Investment Management Co.’s Municipal Income Fund has dropped 12.3 percent since Nov. 3, when the Federal Reserve said it would undertake a round of quantitative easing, known as QE2, by buying $600 billion in U.S. debt.

Yields on top-rated tax-exempt bonds due in 10 years climbed to a four-month high as the market absorbed the highest weekly issuance of municipal debt in at least seven years. California led states and local governments issuing $16.3 billion this week.

Credit-default swaps on Sprint Nextel Corp. jumped to the highest in more than two months after Moody’s Investors Service said yesterday it’s reviewing whether to cut its rating on the third-largest U.S. mobile phone carrier. They rose 9.2 basis points to 398.5, according to CMA.

“The question becomes will the federal government help,” Buffett, 80, said at the U.S. Financial Crisis Inquiry Commission in New York on June 2. “I don’t know how I would rate them myself. It’s a bet on how the federal government will act over time.”
Flood of Issuance Amidst Head Winds

A flood of issuance from California and other states comes amidst downgrades of Philadelphia, problems in California, and renewed fears of sovereign default in Europe.

Please consider the Wall Street Journal article Head Winds Facing Muni Issuers.
The tumble in long-term municipal bonds last week comes as a flood of states and municipalities are seeking money in the debt markets, raising the prospect some will have to pay higher yields to lure investors.

California leads the list of planned borrowers. The state alone is planning $14 billion of sales before Thanksgiving.

Investors have been keeping a close eye on the municipal debt markets in recent months, amid reports—albeit rare—of some municipal borrowers struggling with or walking away from debts. Investors also have begun to worry about the future of Build America Bond program and the effects of the Federal Reserve's bond-buying efforts.

That came to a head last week when yields on consulting firm Municipal Market Advisors' index of AAA-rated 30-year municipals jumped up 15 basis points—or 0.15 percentage point— from the prior week. That is the biggest move in 18 months, said Matt Fabian, managing director at the firm.

Difficulties have been felt by even high-quality borrowers. Last week Harvard University was forced to pay an interest rate above a key benchmark rate and reduce the amount of debt it sold to close a $600 million bond deal. That got investors' attention, said Mr. Fabian, and helped trigger the price correction in the broader market.

Another concern: the future of the Build America Bond program. The program was designed as part of the Obama administration's effort to help states, cities and other local government entities borrow in the bond markets and lower financing costs by offering a federal subsidy.

The gains for Republicans in this month's midterm elections, market participants say, makes reauthorization of the program less likely. "The threat is if that [the BABs program is] not authorized than all that volume comes back to the tax-exempt side," Mr. Friedlander said.
There much more in the article. Those interested in Munis should give it a look.

Bad Timing in California

It is quite typical of California to run into problems at exactly the worst possible time. Le Los Angeles Times reports Bad timing: California seeks bond buyers amid rout in muni market

Yet another way the California Legislature has stuck it to taxpayers: The long delay on a budget agreement this year also delayed the state’s plans to raise cash in the municipal bond market.

Now, Treasurer Bill Lockyer is trying to get investors to buy $14 billion in debt amid a broad sell-off in the bond market overall, and the worst sell-off in many tax-free muni bonds since the financial crash of late-2008.

That will mean higher interest rates on the debt than the state would have paid two months ago.
California Bond Sale Pricing Delayed

CNBC reports Institutional Pricing on California's $10 Billion Notes Delayed
Institutional pricing of California's $10 billion of revenue anticipation notes, which had been scheduled for Wednesday, has been delayed until Thursday due to litigation over a state building sale, the state treasurer's office said on Wednesday.

"The state is required to disclose the lawsuit to investors, and did so this morning. Retail investors on Monday and Tuesday ordered $5.89 billion of the RANs. Those orders now have to be reconfirmed in light of the new disclosure," a statement from Tom Dresslar, spokesman for California Treasurer Bill Lockyer said.

The building sale and lease-back plan was approved by the governor and legislature to help eliminate California's budget deficit.

Earlier on Wednesday, Lockyer issued a notice for the deal's preliminary official statement that said a taxpayer lawsuit was filed in state court on Tuesday seeking to block the sale of 11 state office properties.
Build America Bond Program About to Expire

Build America Bonds, a brainchild of the Obama Administration, was supposed to be a "temporary emergency" program. The debate now is whether to kill it.

David Reilly writing for the Wall Street Journal says Build America Bonds Need Tearing Down
Started in early 2009, the program offered state and local governments a subsidy to help issue debt when credit markets were largely frozen. The idea was that government borrowers, who largely sell tax-exempt debt to individual investors, needed help tapping the wider institutional market.

To this end, the U.S. government decided to rebate to state and local governments 35% of the interest paid on a taxable bond issue. That allowed them to sell debt with yields comparable to, say, corporate issues, and so garner wider investor attention, yet ultimately pay less interest. The program has proven popular — more than $150 billion of Build America Bonds have been issued as of October, according to the Treasury Department.

Whether that flies will depend on the lame-duck session of Congress that begins on Monday. The best course would be for legislators to end what is essentially just another bailout.

Why? State and local governments need incentives to get their financial houses in order, as painful as that might be. By subsidizing the cost of borrowing with this program, the federal government reduces the incentive to do so.
I concur with David Reilly. States need to get their fiscal budgets in order. Going into more debt does not work.

Muni Risk-Reward Setup is Horrid

Regardless of whether the Congressional lame duck session approves a permanent extension to the temporary Build America Bond Program, munis are very richly priced in this backdrop of increasing global uncertainty and likelihood of additional bond downgrades and even defaults.

I see no point in investing in munis at all. The sector crashed in October 2008 and there is no reason it can't (or even that it shouldn't) crash again.

Mike "Mish" Shedlock
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