“Intercalary” February: An Extra Day of Bond News
Leap Year means 29 days in February 2012, so there is an extra day of bond news this month.
New issue supply remained modest, demand strong
The new issue supply of municipal bonds remained fairly modest in February and investor demand remained strong during the month. Prices in the U.S. Treasury bond market held up during the month and, as a result, January’s low bond yields continued into February.
Minimal Greek debacle yield impact amid continued refinancing
Greece’s “non-default” default had minimal impact on domestic bond yields – as did certain threatened and real municipal bond issuer bankruptcies. Many municipalities continue to reduce their costs by refinancing debt at a pace not seen in several years to take advantage of borrowing rates at 40-year lows. Issuers have refinanced more than $16 billion of debt through the first two months of the year. Generally, most U.S. states operating budget constraints continue to ease with several notable exceptions.
Slightly higher bond yields not expected to climb much in near team
The January jobs report, released in the early part of the month, was stronger than many expected signaling some needed good news for the economy. The positive employment numbers put a little pressure on bond prices forcing bond yields a little higher by the end of the month. This positive development aside for income investors, we do not expect to see significantly higher bond yields in the near term.
Stockton would be largest U.S. city to file for bankruptcy
The City Council of Stockton, California voted last Tuesday to enter mediation with its creditors. It hopes to renegotiate with its creditors in order to avoid filing for bankruptcy. If it files, it will be the largest U.S. city to file for bankruptcy. The City Manager, Mr. Bob Deis, recently noted the city faces a $20 million deficit in the upcoming fiscal year and an unfunded $450 million retiree health care liability. These benefits were greatly expanded in the 1990s around the same time bonded debt levels increased tied to economic expansion projects.
Jefferson County charting new territory for investors and issuers
Jefferson County filed a cross appeal notice that it may challenge the bankruptcy judge’s January ruling that allows sewer revenues to be used for debt service. A total of eight parties are now challenging portions of Judge Bennett’s rulings. Nothing is certain as it relates to Jefferson County, Alabama other than it will be in the news for many months to come and that it is charting new territory for investors and issuers. Bond investors need to watch this one closely to see if debt-holder interests are respected by the courts.
Credit positive developments across the country in February
There were several notable credit positive developments during the month:
- Detroit – Detroit, Michigan and unions representing firefighters struck an agreement helping the city close its deficit. Municipal employee unions agreed to a number of concessions including a 10% pay cut and health care and pension benefit reductions.
- California – The State of California’s ratings outlook was revised to “positive” from “stable” by Standard & Poor’s ratings service; the state benefitted immediately from this upgrade when it priced an issue and took orders at a 2.70% yield for 10 years.
- Dekalb County – DeKalb County, Georgia returned to the credit market and borrowed for 10 months at 0.22%. This is very positive development for the county given last year’s “super downgrade” of its unlimited tax general obligation bonds. Since the downgrade, the county has improved its finances, clarified its financial picture and improved transparency of its financial reporting. The lesson for issuers here – keep finances in order, report clearly and promptly and investors will eagerly lend funds.
- San Diego/New York – San Diego, California mayor and New York Governor Cuomo each launched pension reform initiatives.
- Michigan – Michigan passed a new law featuring an enhanced intercept structure creating an extra layer of security for bondholders. This enhanced structural feature will increase investor confidence and should lower borrowing costs for many Michigan school districts.
Obama’s 2013 budget seeks to limit municipal bond tax exemption
Lastly in the February news department, President Obama’s 2013 budget released mid-month calls to cap the tax-exempt interest deduction at 28%. The proposed budget also seeks to revive the mothballed Build America bond program. The Administration estimates the tax-exempt interest cap will reduce the deficit by $584 billion over the next 10 years.
In our view – presented in our recently published white paper, Tax-Exempt Municipal Bonds: The Case for an Efficient, Low-Cost, Job-Creating Tax Expenditure, based on thorough analysis – the magnitude of budget savings is grossly overstated by the Administration’s proposed budget.
The deduction cap idea has little support in Congress at this point. That said, the threat of retroactive taxation to is very troubling to us. We will continue to follow the developing municipal bond tax exemption story very closely and publish our views on a regular basis.
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Ronald P. Bernardi
President and CEO
Bernardi Securities, Inc.
March 7, 2012