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One of the penalties for refusing to participate in politics is that you end up being governed by your inferiors. -- Plato (429-347 BC)

Tuesday, July 26, 2011

The Long and Short of the Deficit Crisis & Opinions of the Muni Market

Bill Smith, Editor: This article was reprinted with permission of Galvin Murphy, Editor-In-Chief, of The Bond Buyer. The original article is offered via subscription to their readers. Anyone wishing to copy, reprint or use this article should contact the original publisher. Links to this article are acceptable. Also, Rick Calhoun, a contributing author to the ARRA News Service, is quoted in the article.

by Christine Albano, The Bond Buyer:: With Congress facing an Aug. 2 deadline to raise the federal debt ceiling and the threat of a U.S. default looming, municipal market professionals are concerned about possible long-term credit affects stemming from the would-be solution crafted by Republicans and the White House to resolve the deficit crisis.

While experts agree there is a lot of uncertainty and few answers as to how and when the impasse will be resolved, they are somewhat divided over how the dilemma is currently affecting investors’ behavior and trading activity.

Overall, the market was mostly steady through Friday despite the arrival of a record $8.3 billion of new municipal supply for 2011, some slight Treasury weakness, and the announcement last Tuesday that Moody’s Investors Service put five of 15 triple-A rated states on review for a possible downgrade.

The action, which targeted Maryland, South Carolina, New Mexico, Tennessee, and Virginia, is a result of the states’ fiscally sensitive relationship with the United States’ sovereign credit and affects $24 billion of rated debt.

The muni market also showed no immediate reaction to news Friday that the Senate rejected a House plan to substantially cut government spending and raise the $14.3 trillion limit contingent on a balanced budget proposal.

Moody’s also earlier in the month put the triple-A rating of the U.S. government on review for a possible downgrade.

It said the five states could be downgraded if U.S. debt is downgraded due to a default — a move that municipal experts say could cause investors to demand higher yields to compensate for the potentially less-than-stellar credits.

Meanwhile, the rating agency also suggested that the United States should eliminate its statutory limit on government debt to reduce uncertainty among bond holders.

The current wide divisions between the House and the Obama administration over the debt limit creates a high level of uncertainty and “causes us to raise our assessment of event risk,” Moody’s analyst Steve Hess said in a recent report.

Fred Dickson, chief investment strategist at D.A. Davidson, a Montana-based brokerage and money management firm, on Wednesday advised investors to be optimistic and patient during the conflict resolution. “We think there is a one-in-100 chance that the government will not raise the debt ceiling,” he said. “We looked at the various events like the Japanese earthquake and tsunami, the oil price spike, and European debt crisis, and we think that this crisis, at worst, would lead to some short disruptions, and perhaps a 2% to 3% drop in the stock market.”

The Bond Buyer asked a handful of municipal experts to weigh in about how they think see the debt-ceiling dilemma affecting the muni market overall, and if they think Congress will meet the Aug. 2 deadline.

Clark Wagner, director of fixed income and a portfolio manager at First Investors Management Co. “It’s just another one of the many uncertainties in the fixed-income market in general right now. If we saw a large issue from one of the states that were put on credit watch, that would be more interesting than a couple of bonds from Maryland trading [in the secondary market.]

“There is so much uncertainty, but you’re not seeing much trading in anticipation of changes in credit ratings and you haven’t seen credits trading cheaper. There is very good demand in the market right now. … There is a lot of money in the market and the main theme is cash looking for bonds.

“The muni market will probably react to the type of agreement, and we will follow what the Treasury market does until we get some resolution and then the impact will be on credit. The broader concern is what will the effect be on muni credits. [Standard & Poor’s] just said there is a 50% chance of a downgrade of the U.S., which would affect prerefunded and escrowed bonds, and the five states that were put on credit watch, and so many other credits that are linked to the U.S. government, like grant anticipations, hospitals, and housing bonds.

“With so many different linkages, it’s really hard to follow all the threats. [A downgrade] is not going to be good overall, but it’s not going to be a disaster either because the ratings would probably go from triple-A to double-A-plus.

“That’s the bigger issue — what does it mean for an issuer whose bonds were prerefunded and now might be escrowed in double-A bonds that were triple-A? There are so many questions hopefully we won’t have to answer.”

Rick Calhoun, First Vice President Sales at Crews & Associates in Little Rock, Ark. “Low rates combined with a degree of uncertainty from Washington continue to suppress bond trading and retail activity. We have been getting many calls from surprised investors who own prerefunded munis or municipal issues that are escrowed in U.S. Treasuries since they have now gone on Moody’s credit watch for possible downgrade. The same is true for housing and other issues that are collateralized in government bonds or guaranteed by government agencies, such as [the Department of Housing and Urban Development].

“I don’t see investors dumping prerefunded and escrowed bonds. So far, at least, none of our clients have. That’s not to say they won’t in the future if, in fact, U.S. debt is downgraded. Their immediate response has been great surprise that their holdings have been put on credit watch, especially since the original purchase was made because of their perception that an escrowed bond guaranteed by the U.S. Treasury is as good as it gets.

“The market had just begun to recover from the Meredith Whitney flu when investor confidence was dampened by the debt-ceiling talks in Washington. However, many muni investors have become more savvy and are looking at bond fundamentals closer than ever before. I am not at all confident that there will be a swift resolution because Washington is more polarized than ever.”

Howard Mackey, manager of underwriting, sales and trading at Rice Financial Products, and president of its broker-dealer division.
“Our view is that they are going to get something done, even if it’s a temporary fix by the Aug. 2 deadline. I don’t think Congress would put the U.S. Treasury debt into question to a point where there is a downgrade or potential default.

I think it’s a lot of political jawboning, but I don’t think the market is reacting to the headlines. We haven’t found any customers that have been terribly concerned about it. There was a little weakness in Treasuries on Thursday, but I don’t think it’s anything related to these debt talks.

“The municipal market is pretty steady. Any changes by [Municipal Market Data] have been very slight bumps and cuts, and there is nothing in the municipal market that suggests there is a problem. We have gotten deals done, even with the heavy calendar, so there is no evidence that this is a worry for our credit markets.

“I think if they were not able to pass the measure, then I think a lot would depend on how other nations that hold our debt react. China and other nations own a tremendous amount of our debt, and if they started selling or voicing strong concerns, that could have a fairly substantial effect on the municipal market.

“At this point, it would be interesting to see if there is any significant issuance out of the states [that were put on review by Moody’s]. Overall, I think [the review for downgrade] was expected, but I don’t think it is causing a major amount of concern. With some fund managers it might have an effect, and they will demand more yield to compensate for the change in the credit ratings, but at this point you are not talking about defaults or any changes in the stability of these particular credits.”

Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management in Oak Brook, Ill. "The sword of Damocles gets a little heavier each day that the federal debt ceiling is not passed. The muni market doesn’t appear to be heavily weighting the risk into pricing levels, but that’s likely to change if Treasury bond yields start to rise and the market begins to worry about specific cash hold-backs to governments and municipal agencies. The market may well begin to pay up for credits that are essentially immune from federal payments.

“At this point, the probability of solving the crisis by Aug. 2 is about 65%, in my opinion. We continue to monitor the situation and keep it in mind as we make investment decisions. Panic transactions are rarely worth doing. However, at the moment, market prices don’t seem to be moving much on names that could be more directly impacted.”

Tags: The Bond Buyer, muni markets, national deficit, Deficit Crisis, Christine Albano, Clark Wagner, Rick Calhoun, Howard Mackey, Richard Ciccarone To share or post to your site, click on "Post Link". Please mention / link to the ARRA News Service. Thanks!
Posted by Bill Smith at 4:12 PM - Post Link


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