Larry Summers, we hardly knew ye. Or perhaps we know you too well? The succession issue at the Fed and the prospect of a Summers nomination as Chairman have been weighing on the financial markets. As they say, markets hate uncertainty and Summers has been pegged, fairly or unfairly, as a potentially more hawkish and therefore more disruptive influence on future monetary policy. When Mr. Summers decided to withdraw his name from consideration over the weekend, thereby boosting current Vice-Chairwoman Janet Yellen’s chances, bond traders welcomed the news, driving the yields on the benchmark 10-year Treasury below 2.80% before settling around 2.85% this morning.
Of course, more volatility could be in store for the rest of the week as market participants await the results of tomorrow’s FOMC meeting. The Committee is widely expected to announce the beginning of its tapering efforts at this week’s session, so the only factors that could move the market would be the actual size of the initial bond purchase reduction and any other hint or forecast about the future course of monetary policy.
New Issue Market
In the municipal market, last week’s rally extended into Monday, with yields dropping by as much as 10 basis points in the belly of the curve and six basis points on the long end. Tax-exempts recaptured some of their prior underperformance relative to Treasuries: the inter-market ratio dropped below 100% again in the 10-year range, after averaging 104% over the last 90 days. The 20-year and 30-year ratios also dropped by two percentage points each, although they remain very attractive at 115% and 114%, respectively.
When it comes to disclosure, above and beyond the actual financial information provided, an issuer’s chronic inability to complete disclosure on a reasonably timely basis may be viewed as indicative of more serious internal control or managerial problems.
Of course, the firmer tone was predicated on this week’s very limited new issue calendar, as many issuers preferred to wait out rather than deal with the potential post-FOMC volatility. On the negotiated side, significant deals include a State of Washington Federal Highway Grant Anticipation Revenue issue ($295 million, Aa3/AA-/NR) and yet another refunding from Dallas Fort Worth Airport ($259 million, A2/A+/A). The competitive calendar will have an educational theme this week, as it will feature a $333 million Virginia College Building Authority issue and a $300 million Ohio Common Schools G.O. issue.
Market participants also took comfort in drastically reduced new issue volume forecasts for the rest of the year. The industry started out the year expecting around $400 billion in total issuance for 2013. Given the sharp rise in rates since May, both new money and refunding volume are expected to drop dramatically during Q4, resulting in total volume of just $300-325 billion.
Puerto Rico Update
How about a collective Hallelujah? Last night, the Commonwealth of Puerto Rico finally released its Comprehensive Annual Financial Report (“CAFR”) for the fiscal year ending 6/30/2012. Although we haven’t had a chance to review this 300-page document, just the fact that it got completed constitutes a moral victory of sorts for the beleaguered island. When it comes to disclosure, above and beyond the actual financial information provided, an issuer’s chronic inability to complete disclosure on a reasonably timely basis may be viewed as indicative of more serious internal control or managerial problems.
Of course, when dealing with data that are more than 14 months old, one would not expect to uncover any major surprise here. That said, we will take a deep dive into the CAFR over the next few days and report back on what we find.
While we’re on the subject, a recent report from broker-dealer Loop Capital confirmed what everyone has suspected all along: the top holder of all PR debt combined holds a stunning 40% of the total. As Loop Capital put it, “this enormous concentration with one investor poses risks for the other bondholders: what if they decide to sell? What if they simply stop buying?”
Incidentally, a representative of the same top holder was on CNBC this morning, trying to defend their position. At this point, it seems to us the investment merits of Puerto Rico are no longer the issue. The real issue is whether or not normal fiduciary standards have been breached by such undue concentration in a single credit.
Illinois and Chicago Update
For months now, there has been speculation that Illinois legislators are dragging their feet on pension reform to see if Bill Daley will replace Pat Quinn as the Democratic gubernatorial candidate. That theory went out the window with Daley’s surprise withdrawal from the race yesterday. Will this strengthen Pat Quinn’s hand going forward? One can only hope.
Any resolution of the state’s pension issue should also improve the City of Chicago’s credit outlook. Yesterday, Standard & Poor’s Rating Services revised its outlook on Chicago’s A+ G.O. rating to negative from stable, citing the city’s pension crisis.
Incidentally, Chicago also scores poorly on Standard & Poor’s new “Institutional Framework” (IF) scale for local governments. The IF score stems from the recognition that local issuers are fundamentally constrained by their state’s legal and operating environment. S&P’s IF scores use a 1-5 scale, with “1” being the strongest, and covers the following four areas: “(1) predictability; (2) revenue and expenditure balance; (3) transparency and accountability and (4) system support.”
While most cities and counties in Illinois have earned either a “2” (strong) or “3” (adequate) score, Chicago is the only major metropolitan area with a “4” (weak) rating. No wonder Chicago GOs have been trading around +200 versus AAA, a level usually reserved for weak BBB credits.
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