Market Outlook

Late August markets do lend themselves to potential volatility and that appears to be the case so far this week. With few real bidders around, the Treasury market continued to be pressured yesterday as rates made fresh two year highs. Yields on both the 10-year and 30-year bonds came within earshot of the next rate “handles,” peaking at 2.88% and 3.90%, respectively.

Treasuries did find a flight-to-quality bid this morning as emerging markets around the globe – India in particular – continue to fall apart. As the marginal beneficiaries of the tremendous excess liquidity created by the Fed, these markets now find themselves paying the piper.

Detroit area issuers continue to pay dearly for Motown’s sins …

Municipals outperformed taxables on the way down last week but continue to grind lower at this writing.

New Issue Market

The tax-exempt market should see very light new issue supply this week, with just over $4 billion on the calendar, anchored by an $849 million New Jersey Transportation Trust Fund Authority deal (A1/A+/A+). The longest maturity for this relatively uncontroversial issue is expected to be priced at 5.25% in 2044, or about +88 versus AAA.

Detroit area issuers continue to pay dearly for Motown’s sins: a $92 million state aid revenue note issue for the Detroit School District, maturing in August 2014, was reportedly priced this morning to yield a whopping 4 ½%. For perspective, the AAA scale for one year paper is currently a mere 0.19%! (and, no, we didn’t misplace the decimal point). It wouldn’t surprise us to see investors back up their truck for this tremendous opportunity.

Detroit Update

Detroit’s retirement system representatives reportedly met with Emergency Manager Kevyn Orr’s team last night to dispute the size of the city’s pension liabilities. As usual, the key object of contention is the rate of return assumption used by in estimating such liabilities. By lowering the return assumption by only one percentage point, to 7.00%, the Orr team came up with a liabilities estimate of $3.5 billion, almost five times the previous estimate. The pension funds will try to argue that the 7.00% assumption is too low, assuming they can still do it with a straight face, given today’s low interest rate environment.

Ironically, the retirement systems’ efforts to challenge the size of the pension liabilities may backfire on them, should they ultimately lose the argument. If Detroit does get approval to file Chapter 9, and if unfunded pension liabilities are found to be unsecured claims on city assets, the unions may wish they had argued for a larger pension liability estimate. A larger claim may secure them a larger pro rata share of any settlement within the unsecured creditor class.

Bond Insurers’ Exposure to Muni Credit Trouble Spots                                                                                                 

While writing our latest piece on Puerto Rico, it occurred to us that we hadn’t seen a recent summary of the bond insurers’ exposure to the various Puerto Rico credits in quite a while. A little inquiry within the Twitter muni community led us to a piece by Mark Palmer, an equity analyst at BTIG who follows the bond insurers. The report, dated July 1st 2013, listed AMBAC, Assured Guaranty and MBIA’s exposures to Puerto Rico as of 3/31/13.

Since most the insurers have just reported their financial results for the second quarter, we thought we’d update Mark’s numbers through 6/30/13 while also adding information on other muni insurers such as Syncora and FGIC.  Furthermore, as long as we were combing through the companies’ earnings reports, we also decided to compile their exposures to other muni credit hot spots, such as Detroit and Chicago. Our findings are displayed in Table 1 (Of course, the data shown are meant to be illustrative only and we make no representation as to their accuracy or completeness).

Another few caveats to keep in mind while reviewing these numbers: (1) all figures are as of 6/30/13, unless otherwise noted (in the case of AMBAC, the numbers probably didn’t change materially from Q1 to Q2); (2) the exposures to individual issuers came from the companies’ largest exposure reports, so smaller PR credits could have been missed; and (3) the aggregate exposure was obtained from or confirmed by the companies’ investor relations team whenever possible.

Not surprisingly, Assured Guaranty leads the field in terms of Puerto Rico exposure, just by virtue of being the most active insurer currently. Its aggregate exposure came in just shy of $6 billion, much of it comprised of the Commonwealth’s G.O.s and the very shaky PR Highways credit. MBIA/National Public Finance Guarantee Corp. is reportedly on the hook for just over $5 billion of PR paper, concentrated in three major issuers: PR G.O., PR Highways and PREPA.

As far as exposure to Detroit is concerned, FGIC appears to have the lion’s share, with $925 million in Detroit G.O.s alone and another $514 million in the Water & Sewer bonds. Most of the other insurers show only modest dollar exposure to Motown, with the exception of Syncora which has guaranteed more than $300 million of the Pension Obligation Bonds, arguably the worst secured within the city’s capital structure.

Looking ahead, if the City of Chicago ever got into trouble, Assured Guaranty would bear the brunt of it, with $2.65 billion in Chicago G.O.s and another $1.45 billion in Chicago Board of Education, a closely related credit. MBIA for its part has insured at least $2.8 billion in Chicago-related credits, split almost evenly between G.O.s and Board of Ed.

With Chicago G.O.s 5.00% due 1/1/2034 (cusip 167486ds5) last trading at 5.97% or +182, a rather wide spread for an A3/A-/AA- G.O. credit, there is certainly room for bond insurers to add value here, assuming they can stomach the additional credit exposure.

Disclaimer: The opinions and statements expressed in this column are solely those of the author and Axios Advisors, who are solely responsible for the accuracy and completeness of this column. This column does not reflect the position or views of RICIC, LLC or MuniNetGuide.

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