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U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P
Managing Municipal Debt in Today’s MarketManaging Municipal Debt in Today’s Market
August 13-17, 2011
NASACT 2011 Conference
Alex WallaceManaging Director
U.S. Bancorp Municipal Securities Group
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 2
Municipal IssuanceMunicipal Issuance
Municipal Supply*
*2011 YTD 1/1 - 8/1
$142
$432$410
$390
$430$389
$408
0
100
200
300
400
500
600
2005 2006 2007 2008 2009 2010 2011
$Bill
ions
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
BAB
Non BAB
# Trans
Tax-Exempt Rates Below Historical Averages*
2.79%
3.60%
4.61%
0.90%
2.26%
3.88%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
5yr MMD
Perc
ent
agea
s
10yr Average
8/11/2011 MMD
*Comparison of 8/11/2011 AAA MMD v. 10-yr Historical MMD averages
10yr MMD5yr MMD 30yr MMD
Source: TM3Source: SDC
Municipal Issuance by Mode*
*2011 YTD 1/1 - 8/1
Municipal Issuance by Market Access*
*2011 YTD 1/1 - 8/1Source: SDCSource: SDC
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011
Perc
enta
gens
Private
Negotiated
Competitive
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011
Perc
enta
gens
Variable Rate
Fixed Rate
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 3
Municipal Market Issues Coming into 2011Municipal Market Issues Coming into 2011
Legislative
Reinstatement of ARRA programs (temporarily or permanently) Elimination of tax-exemption Impacts of Dodd-Frank Wall Street Reform Act
Potential Supply / Demand Imbalance
Expectation for overall lower volume in 2011 Outflows from municipal bond funds Continuance of cross-over buyer support in the municipal market Underperformance of municipal bonds versus other asset classes
Interest Rate and Credit Spreads
Sustainability of low interest rate environment. Inflationary concerns looming Tax-exempt and taxable relationship (i.e., ratio) Credit spreads under pressure, especially for more storied credits
Credit Differentiation
Investors and rating agencies are more focused on credit drivers, liquidity, and transactional risks
Emergence of headline risk and perception of defaults in the municipal market Future of bond insurance Issuer disclosure requirements
Variable Rate Market
An estimated $112 billion in expiring Letters of Credit and Standby Bond Purchase Agreements in 2011
Outflows from tax-exempt money market funds Impact of Basel III on banks’ ability to provide liquidity at acceptable prices Floating rate alternatives (Direct Purchase, Floating Rate Notes, Put Bonds, etc) Swap Exposure – estimated mark-to-markets of approximately negative $300 Billion
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 4
Fixed87%
Indexed Note6%Variable
7%
Negotiated75%
Competitive22%
Private Placement
3%
2011 Municipal Issuance2011 Municipal Issuance
Source: Thompson Reuters
Annual Municipal Issuance Volume (Jan. – June) Issuance by Methods (Billions)
Market Commentary Issuance by Rate Mode (Billions)
Year-to-date municipal issuance volume at a 10 year low Municipal issuance is down 40% from 2010 levels Approximately $142 billion of new debt has come to
market this year in the public market 75% of all volume has been negotiated year-to-date 87% of year-to-date primary public market volume has
been in fixed rate mode v. 7% in variable rate mode Private market activity growing
- Direct Purchases- Renewals- Remarketing Takeovers- Swap Novations
$195
$239$215
$244
$207
$263 $268
$223$234
$142
$0
$50
$100
$150
$200
$250
$300
YTD2002
YTD2003
YTD2004
YTD2005
YTD2006
YTD2007
YTD2008
YTD2009
YTD2010
YTD2011
$Bill
ions
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 5
Municipal Defaults (7/2009 – 8/2011)Municipal Defaults (7/2009 – 8/2011)
Sector All Notices Defaults Reserve Fund Draws
Par ($MM) # Trans. Par ($MM) # Trans. Par ($MM) # Trans.
Land Secured 4,412 247 2,756 148 1,352 86
Toll Road/ Transit 4,666 7 889 4 1,419 1
Tribal 940 4 940 4 n/a n/a
IDB 1,193 31 889 15 300 15
Housing 831 64 671 48 115 10
Retirement 2,182 65 782 26 292 9
Hotel 696 12 404 7 194 4
Other “Risky” Sectors 13,423 136 1,381 53 10,319 49
Safe Sectors* 7,492 48 7 3 4,910 18
Total $35,836 614 $8,719 308 $18,902 192
Initially Non-Rated $10,293 433 $5,947 259 $2,573 118
Initially Insured/ LOC Bonds $14,595 86 $624 5 $9,271 48
Initially Rated/ Uninsured $10,115 51 $1,640 18 $6,844 20
*GO/ Wtr/Swr/ Sales TxSource: Municipal Market Advisors
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 6
Municipal Yield CurveMunicipal Yield Curve
Market Commentary
Tax-Exempt MMD Yield Curves
7/1/2010 – 8/1/2011
Yield curve is historically steep – 2-30 year curve is over 400 basis points
Steep yield curve will drive financing structures and decisions made by our clients
Investor Segments
- Short-term: • MMF’s• Corporations• Banks
- Intermediate:• Intermediate Bond Funds • Retail• SMA’s
- Long-term• Bond Funds• Insurance Companies• Bank Trusts• Hedge Funds (Arbs. / TOBs)
0.00
1.00
2.00
3.00
4.00
5.00
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29
Yiel
d
Max AAA GO MMD
Average AAA GO MMD
Current AAA GO MMD
Min AAA GO MMDAverage AAA GO
Current AAA
Max AAA GO
Min AAA GO
Source: TM3
Short Term
Long Term
MMD Date 1 yr 3yr 5yr 10yr 15yr 20yr 30yrCurrent AAA GO 8/1/2011 0.20 0.61 1.14 2.63 3.36 3.82 4.29Average AAA GO 7/1/2010-8/1/2011 0.30 0.80 1.43 2.78 3.49 3.94 4.32Max AAA GO 1/14/2011 0.37 1.11 1.88 3.46 4.32 4.89 5.08Min AAA GO 8/31/2010 0.25 0.48 1.06 2.18 2.76 3.28 3.67
Yield (basis points)
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 7
Historic Long-Term RatesHistoric Long-Term Rates
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
AAA GO 30-yrUST 30-yrMMD AvgUST Avg
LONG TERM
MARKET
LONG TERM
MARKET
High Grade Municipal Index 30-yr Spot (Jan 1990 – Present)
Sept., 15, 2008Lehman Brothers Bankruptcy filing
20 year MMD Average
MMD Historic Low
20 year UST Average
UST Historic Low
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 8
Long-term Ratios: MMD and US TreasuryLong-term Ratios: MMD and US Treasury
Ratios are an important factor in determining future tax-exempt rates and the sustainability of “cross-over buyers”
30yr MMD/UST Ratio
50%
75%
100%
125%
150%
175%
200%
225%
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
Liquidity Crisis
ARS fail Insurers lose
AAA Trading/
leveraged buyers exit market
ARRA
BABs, QSCBs, etc. AMT Holiday
85%
99%
143%
128%
April 15, 2009:1st BAB Deal
Jan. 1, 2011:ARRA Expires
107%
August 1, 2011:105%
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 9
0.0
50.0
100.0
150.0
200.0
250.0
300.0
Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
Spre
ad (b
ps)
AA GO v. AAA GOA GO v. AAA GOBAA GO v. AAA GO
Credit SpreadsCredit Spreads
- Shorter duration
- Current coupons not attractive- Use of web-based portals such as
Buy___Bonds.com
- Use of Mini-Bonds
Credit spreads have tightened but remain at historically high levels.
“Flight to quality” dynamics still exist
Limited exposure to A and BBB rated credits by investors
Retail participation remains a high priority for most issuers
Municipal Credit Spreads Since January 2006
Source: TM3
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 10
(5,000)
(4,000)
(3,000)
(2,000)
(1,000)
0
1,000
2,000
3,000
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
$Th
ou
san
ds
Municipal Bond Fund FlowsMunicipal Bond Fund Flows
Recent negative headlines in the municipal market led to substantial mutual fund cash outflows and increased secondary selling pressure.
Tax-Exempt Bond Flows (Funds that Report Weekly)
YTD 2011 $22bn Outflows
YTD 2011 $22bn Outflows
Jan. 1, 2011Jan. 1, 2011
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 11
Historic Short-Term RatesHistoric Short-Term Rates
LONG TERM
MARKET
LONG TERM
MARKET
Short Term Indices: SIFMA & LIBOR (Jan 1990 – Present)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
SIFMA
1mo LIBOR
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 12
Short-term Ratios: SIFMA and LIBORShort-term Ratios: SIFMA and LIBOR
0.00
0.10
0.20
0.30
0.40
0.50
0.60
Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul -11 Aug-11
Perc
enta
ge
(percentage) — SIFMA — 1mo LIBOR — 3mo LIBOR8/2/2010 0.28 0.30 0.448/3/2011 0.08 0.21 0.27Change (0.20) (0.09) (0.17)12m Average 0.24 0.24 0.2912m Ratio of SIFMA to LIBOR 98% 81%
Ratios are an important factor in determining future tax-exempt rates and the sustainability of “cross-over buyers”
Influx of new cash from taxable money market funds – currently represent a significant increase in the number of assets available to purchase tax-exempt instruments
Daily resets are trading 10 basis points through SIFMA
SIFMA v. LIBOR (Aug. 2010 – July 2011)
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 13 13
Variable Rate IssuanceVariable Rate Issuance
ObservationsMoney Market Fund Assets
and Outstanding VRDNs
Variable rate funding continues to provide compelling cost advantages compared to fixed rate debt
Availability of credit enhancement continues to be an issue
Increasing distinction (i.e., trading spread) between lower and higher quality credit providers
- Higher quality banks trading as much as 5bps through SIFMA
- Lower quality banks trading as high as 20bps over SIFMA Cross-over Buyers Include:
Corporations Taxable Funds Foreign Banks Hedge Funds Insurance Companies
Cross-over Buyers Include: Corporations Taxable Funds Foreign Banks Hedge Funds Insurance Companies
(As of July 31, 2011)
$301.2 bn
$356.0 bn
$0
$100
$200
$300
$400
$500
Outstanding VRDNs Tax Free MM Fund Assets
Billi
ons
Crossover Buyers
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 14
Money Market Fund FlowsMoney Market Fund Flows
Money Market Fund Response to Fall 2008 Market Turmoil
$0
$100
$200
$300
$400
$500
$600
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Mon
ey M
arke
t Fu
nd A
sset
s (B
illio
ns)
0
1
2
3
4
5
6
7
8
9
SIFM
A (%
)
Max MMF Assets: $528bn (8/19/08)
MMF Assets Today:$301bn (7/26/11)
Money Market Fund Assets and
SIFMA
Money Market Fund Assets and
SIFMA
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 15
Municipal Market Credit ExpirationsMunicipal Market Credit Expirations
Market CommentaryTotal Muni Credit Expirations
2011 and Beyond
Record volume of expiring bank credit facilities have not taxed the market as expected
Issuers have been successful in extending expiring credit facilities or restructuring outstanding VRDNs
$75
$47$34
$22
$37
$18
$15
$20
$0.0
$20.0
$40.0
$60.0
$80.0
$100.0
$120.0
2011 2012 2013 2014+
Billi
ons
Year
SBPA Expirations
LOC Expirations
- Fixed Rate Bonds
- Direct Placements
- Floating Rate Notes
Source: Bond Buyer
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 16
Alternative StructuresAlternative Structures
Floating Rate Notes (FRN)
Public market issuance
Sold primarily to money market funds, short bond funds and
insurance companies
Index: SIFMA or % LIBOR based
Up to 7 year term
Hard maturity preferred
No remarketing fees
Does not require bank enhancement
Eliminates trading risk volatility
Structure lends to Interest rate risk hedging options
YTD issuance approximately $5B
Direct Purchase
Private market issuance
Principally purchased by commercial banks
Index: % LIBOR based
1-7 year initial mode
Soft Maturity negotiable
No remarketing fees
Eliminates trading risk volatility
Often customized to match existing swap rate structure to eliminate basis risk
YTD issuance estimated at $10B
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 17
Alternative Structures (cont’d)Alternative Structures (cont’d)
Synthetic Structures
Current rate environment attractive for hedging future issuances
- Taxable rates have rallied tremendously relative to tax-exempt rates
- Absolute tax-exempt levels remain historically low – Current MMD* approximately 116 basis points below twenty year average and almost 100 basis points below 6-months ago
MMD “cheap” relative to LIBOR
- Approximately 3 standard deviations to the 6-month average
As of 8/4/2011 Source: TM3
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 18
Impact of US Treasury DowngradeImpact of US Treasury Downgrade
Increased fears downgrade may force already fragile recovery into “double dip”
Initial market reaction counter-intuitive
“Flight-to-quality” to Treasuries (Despite downgrade, still seen as “safe”)
10yr Treasuries dropped to its lowest level since Jan. 2009
Long-term impact on municipal market unknown
Possibility credit spreads may widen
Certain sectors have already been affected and will remain under pressure
GARVEES
Housing Securities
Hospitals
Build America Bonds may be exposed to potential timing and subsidy-reduction risks
Increased uncertainty has dampened primary issuance to approximately $2.8B for the week, the slowest August week since 2003
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 19
Emerging TrendsEmerging Trends
Issuer confidence
Absolute rate levels
Ratios
Counterparty risks (credit enhancement, swaps, and remarketing)
Investor base dynamics (cross-buyers, money and bond fund flows)
Synchronizing disclosure in the public and private markets (especially on parity debt)
New product development
Basel III implementation
Issuers’ debt mix and methods of sale
Continued availability of alternative debt instruments
Floating Rate Notes
Direct Purchases
Put Bonds
Potential return of BABs?
Increases in municipal downgrades / defaults
U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 20
Confidentiality and DisclaimerConfidentiality and Disclaimer
The material contained herein is confidential and may not be shared with parties without the express and prior written consent of U.S. Bancorp.
It has been prepared for informational purposes only. It is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This is not a research report. This material summarizes publicly available material. This material was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Each taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor. Past performance is not necessarily a guide to future performance. This material is distributed to and intended for U.S. persons only. Please see additional important information and qualifications throughout this material, including information regarding the risks of derivatives such as decline in value, settlement risk or liquidity risk. All pricing is on an indication basis only and should not be construed as the terms of the contract as they are neither binding nor guaranteed. Pricing may change due to market forces of supply and demand.
“US Bancorp” is the marketing name used by U.S. Bancorp and its subsidiaries including, U.S. Bank Municipal Securities Group and U.S. Bancorp Investments, Inc. Municipal products and services are available through U.S. Bank Municipal Securities Group and U.S. Bancorp Investments, Inc. U.S. Bank Municipal Securities Group is a separately identifiable division of U.S. Bank National Association and an affiliate of U.S. Bancorp Investments, Inc., member FINRA and SIPC. Investment products and services offered by U.S. Bank Municipal Securities Group and by US. Bancorp Investments, Inc are: Not a Deposit | Not FDIC Insured | Not Guaranteed by the Bank | May Lose Value | Not Insured by Any Federal Government Agency.
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