The Muni Bond market since Meredith Whitney's Report
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The Muni Bond market since Meredith Whitney's Report

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This reviews the health of the Muni bond market since Meredith Whitney's report of December 19, 2010.

This reviews the health of the Muni bond market since Meredith Whitney's report of December 19, 2010.

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The Muni Bond market since Meredith Whitney's Report The Muni Bond market since Meredith Whitney's Report Document Transcript

  • Muni bond market: what happened since Meredith Whitney’s December 19, 2010 Report?Gaetan Lion, April 11, 2012.Somehow, public finances did not collapse as much as she suggested. We can capture the healthof the Muni bond markets through several indicators, including: 1) the price of Credit DefaultSwaps on Munis; 2) the price of one of the largest ETF Muni Bond fund (MUB); 3) the yield onMunis; and 4) Muni default rates. The dotted vertical lines on those graphs reflect the timeMeredith Whitney (MW) released her report.First, let’s look at Credit Default Swaps… MW report essentially captured the peak of the perceived credit risk in Munis through high CDS prices at the end of 2010. Ever since CDS prices have dropped suggesting a marked decrease in Munis credit risk for those 5 large States. Unfortunately we lack more current data.Next, let’s look at the price of the ETF Muni Bond fund (MUB). Price of IShares S&P National Muni Bd. Fd (MUB) When price of the MUB go up 115 it suggests positive trends in 110 terms of decreasing credit risk, 105 declining related yield, etc… Again, MW report caught the 100 bottom of the trend as the price 95 of the MUB bottomed out and 90 rapidly rose thereafter. 85 12/14/2007 12/14/2008 12/14/2009 6/14/2010 9/14/2010 12/14/2010 3/14/2011 9/14/2011 12/14/2011 9/14/2007 3/14/2008 6/14/2008 9/14/2008 3/14/2009 6/14/2009 9/14/2009 3/14/2010 6/14/2011 3/14/2012Let’s look at yields or interest rates on Munis. 1
  • Yield on 20 year Munis Again MW report catches the trend near the top as 6.0% Munis yields peak shortly 5.5% after her report comes out. We could also have looked 5.0% at spreads between Munis 4.5% and AAA rated corporate bonds or 10 year Treasuries. 4.0% But, those spread indicators 3.5% were trendless and not informative. 3.0% 20 -07 20 -04 20 -07 20 -04 20 -01 20 -10 20 -01 20 -10 20 -07 20 -01 20 -04 20 -10 20 -01 20 -10 20 -01 20 -07 20 -10 20 -04 20 -07 20 -04 20 -07 20 -01 20 -04 20 -10 1 -0 06 06 06 06 07 07 07 07 08 08 08 09 09 09 09 10 10 10 11 11 11 11 12 08 10 20As noted the first three Muni bond market signals suggest Meredith Whitney was plain wrongand investors would have profited from doing the opposite of her recommendation. But, thesituation gets muddled when we look at Muni bond default rate next… Muni Defaults as a % of outstandings 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% 90 91 92 93 94 98 99 00 01 02 03 04 05 06 95 96 97 07 08 09 10 11 19 19 19 20 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20Sources: Distressed Debt Securities Newsletter and Putnam Investments.Muni default rates more than tripled after Meredith Whitney’s report suggesting that her call wascorrect. Yet, keep in mind such default rates are still low. Munis default rates at all equivalentbond ratings are far lower than corporate bond default rates. And, recoveries after default are alot higher than for corporate bonds (65% vs 49% Epoch time article 4/05/2012). Thus, MeredithWhitney was directionally correct. But, her call was too Cassandra like as she projected a levelof $ default that was much higher than what ultimately occurred. 2
  • How did the Muni bond market avoid the apocalypse foreseen by Meredith Whitney?In January 2011, Vanguard issued a rebutting report called “California is not Greece” just acouple of weeks after Meredith Whitney. Vanguard conveyed that the Muni bond market wasmore resilient due to structural factors that MW ignored such as: • The vast majority of Munis have long term maturities associated with self-amortizing debt service of over 20 years. Thus, refinancing risk is low and gives public entities time to get their fiscal affairs in order. • State-level debt burden is modest as a % of gross state product, averaging less than 2.8% nationwide with Massachusetts being the most indebted State with a ratio of only 8.3% (around the same time the US ratio was close to 70% and Greece probably over 200%). • Given the States’ low debt ratio, bond default represents a negative trade off including being shut out of the capital markets. Yet States do need financing. • Individual investors (directly or through bond funds) hold nearly 70% of Munis. For a State or a municipality to default and hurt its own taxpayers and voters is not a good idea. By the same token, individual investors being the major Muni bond investors reduce the systemic risk of Muni bonds.Is all well in the Muni bond market?No, it is not. The same Vanguard report mentioned the Pension crisis citing that pension andretirement health care plans were grossly underfunded to the tune of $1 trillion. The financialcrisis aftermath including depressed housing prices did hurt local government revenues throughdeclining sales and property tax receipts. Yet, social transfer payments have increased localgovernment expenditures.Municipal bond defaults, although rare, are at a record high since 1990 as shown earlier. SeveralCalifornia cities and municipalities are struggling to meet their pension obligation and debtservice requirements including Stockton, Vallejo, San Jose, and Hercules. Other municipalitiesin other States are also struggling for the same reasons.Detroit is in near fiscal limbo. The future of its local governance is highly uncertain as it may beaffected by Michigan’s Financial Emergency Law whereby when a local government is unable toshore up its fiscal situation, the State appoints a team of Financial Emergency Managers that takeover. The rest of the States are watching Michigan’s law to see how effective it is and howrelated constitutional and political challenges develop. 3