Wednesday, December 22, 2010

Muni Bond World Reacts to Meredith Whitney Warnings; How to Analyze Muni Rick

A banker emails:
The muni world is just going ape over the Meredith Whitney 60 Minutes piece, as seen here below. I think it will be the small issuers that we will see first get into trouble, but I wouldn’t frame it in a one year time horizon. I think you will see specialized bond deals for projects and special use objects be the ones that get slammed—all it takes is one bad deal to go awry to spook the whole market. Small issuers have less expertise and oversight to allow themselves to get into trouble long before it is noticed. For the naysayers, the anti-Whitney crowd, to chant ‘All is well’ is a bit foolish.

The Federal Government, in an attempt to save the world, created the Build America Bond program (BABs) with its stimulus charity. This caused muni borrowers to load up and have Uncle Sam pay part of the interest. The market is flooded with BABs and the tax-free issues; engorging on the low rates. Sound familiar?

As was the case when Schiff and others predicted the housing collapse, the sellers of muni bonds are obviously annoyed. They are like real estate agents; it’s always a great day to buy. Have you heard radio advertisements for the bond insurer Assured Guaranty lately? A bond insurer making radio ads for the general public? Doesn’t that strike you as kind of strange?
An email received by the banker from a muni-bond broker:
There has been a lot of negative media about the default potential in the municipal market in recent weeks, many of the comments bordering on irresponsible. ... The impact to a municipality of defaulting on debt is relatively catastrophic in terms of ever being able to finance in the future. More importantly, most municipalities debt payments are well under 10% off their budget, thus defaulting would accomplish little. We are confident that municipal defaults will be limited to very specific projects and in states/markets that few of our clients have positions. Knowledge of your underlying credit profile, as we have been reporting over the last several years, is your best defense when questioned by your board or regulators. Let me know if you have any additional questions.
And a muni credit analyst at a brokerage firm issued the following report on how to look at muni risk:
I’ve had several discussions with clients following the 60 Minutes piece with Meredith Whitney concerning municipal credit. While I agree with her opinions on a macro level regarding the pension funding issues and the effect of state aid payment withdrawals on local governments, her conclusions of wide spread defaults are vastly overblown. Regardless, it doesn’t hurt to take this opportunity to engage clients with a more detailed look at the underlying credit profile.

In addition to the traditional metrics we look at such as Debt to Assessed, Per Capita Debt, Overlapping Debt and Debt Coverage, our new Municipal Credit Profile Sheets provide the following, which can be helpful in the credit analysis process:

See the Example Below, the IL Bartlett Park District BABS:

1. GO Debt Limit:

a. Some local municipalities must adhere to a statutory debt limit that is commonly expressed as a percentage of the total principal amount of GO debt relative to the district’s assessed value. The Bartlett Park District has a 2.875% debt limit, allowing for a maximum of $122,602,780 in outstanding GO debt. Given that the district has a debt to assessed ratio of 0.77%, there does not appear to be any debt issuance capacity constraints in the near term.

2. Property Tax Levy vs Property Tax Collections:

a. The property tax levy is simply the total amount billed to taxpayers and the property tax collections shows what amounts have been collected. Dividing the collections by the levy provides a “collection rate”. The inverse (one minus the collection rate) is the delinquency rate.

3. Property Tax Collections vs GO Debt Service:

a. Much like the Debt Coverage Ratio we use for revenue bonds, GO bonds secured by property taxes can provide the same measure by dividing the total property tax collections by the maximum GO debt service payment the district will experience during the life of the outstanding bonds. Here, Bartlett Park District has collected approximately $5.6mm in property taxes with roughly $2mm in debt service which translates into a 3.00x coverage ratio

4. Beginning Net Assets to Ending Net Assets:

a. Depending on how the municipality is structured either within the umbrella of a “parent” municipality or a “stand alone” district that operates autonomously, an analyst can review the change in net assets or change in total fund balances. Here the Bartlett Park District’s net assets improved from 2008 to 2009 for an ending net assets balance of just over $23mm.

b. Reasons for a decline in net assets or a reduction in fund balances can vary. Disposal of equipment might reduce a municipality’s net assets or declining operating revenues. By clicking on the hyperlink containing the bond’s official statement or financial statement, the user can identify the reason for this change.

c. Keep in mind that if you are looking at a special utility or services district, the net assets profile may be negative. One example would be the Woodlands Road Bonds we looked at yesterday in inventory. If a district such as this one operates for the sole purpose of servicing a utility system or long term infrastructure, the balance sheet might be skewed by the carrying amount of debt relative to the assets. Often, a district such as this would only carry the debt of the project while the “parent” municipality, being the City of Woodlands TX here, carries the assets and generates most of the revenues derived from the project. These districts also do not likely have the authority to levy taxes as this is usually done at the city or county level so even those current assets (cash) are not reflected in the balance sheet.

5. Hyperlinks:

a. There are countless other data sets that can be found within the bond’s official statement and financials. If an investor is worried about the withdrawal of state aid for a local municipality, then it would be prudent to identify the percentage of that municipality’s state aid revenues relative to all revenues received in the most recent fiscal year.


  1. Ah, then as long as municipal defaults are contained (are regional, not national in scope), we know that, based on collection rates, which have varied little over the last 30 years, risk exposure in a diversified portfolio of muni bonds is x%. Never heard this before...count me in! As long as The Bernank keeps the press running, all should be well.

  2. Any analysis that fails to take into account the possibility of a 'new normal', or a long term decline in both wages and property values is potentially & seriously flawed.

    Do you believe the long term prospects for the USA economy remain unchanged, that we'll return to an 3-4% annual growth rate?

    I would expect a serious examination of negative real growth is required here. We are now seeing the fruits of a relentless 40+ year de-industrialization the US.