Coming on the heels of a lighter-than-expected payrolls number last Friday, today’s FOMC minutes gave bond bulls even more support by delaying expectations of any rate action until late 2015. With European central banks still in an easing mode, it’s certainly hard to see a catalyst for an upside breakout on rates at this time. The yield on the benchmark 10-year Treasury bond appears well-ensconced inside a 2.50-2.70% trading range.
Having outperformed Treasuries over the last two weeks, the municipal market is in a state of limbo currently, as cross-market valuations are no longer compelling. A modest backup in yields may actually be a welcome development at this point.
New Issue Market
This week’s new issue calendar is creeping up above the $5 billion mark again. However, this modest rise in supply should not make much of a dent in the tax-exempt market’s solid technical underpinnings. While fund flows have been modestly negative over the past 2 weeks, there appears to be enough cash sitting on the sidelines to absorb any additional bond offerings.
It also helps that the bulk of the new issues will consist of tried-and-true high grade names that should be well-received by the market, namely the New York City Transitional Finance Authority ($650 million), New York Metropolitan Transportation Authority ($500 million)and Energy Northwest Corp. ($647 million).
Puerto Rico Update
Puerto Rico officials have been going out of their way to deny any rumor of a debt restructuring. Yet they continue to hire advisors who specialize in… you guessed it, restructuring. In March, the GDB announced it hired an affiliate of Millstein & Co. as a financial adviser. Then last week, it also brought the law firm of Cleary Gottlieb Steen & Hamilton LLP on board as an advisor. Both of these firms are known for their extensive experience in restructuring sovereign credits. What are investors to make of this? At some point, it seems the Padilla team “doth protest too much.”
… never a dull moment in munis.
Among all PR public agencies, the most obvious target for potential restructuring, in our view, would be PREPA. Since energy costs have been identified as one of the major causes for the island’s lackluster economic performance, the Authority has found itself in the crosshairs of legislators and investors alike. Understandably, its bonds have been trading in the 60 dollar range, reflecting expectations of an eventual principal haircut. For instance, a large block of PREPA 5 ¼% 7/1/27 (cusip 74526QYY2) traded yesterday into a 58.75 bid, down more than 10 points from a month ago. As we point out in our latest update on PREPA (you can write us at email@example.com for a copy), time may be running out on the Authority.
A Major Breakthrough in Detroit
As we got ready to write this week’s column, the City of Detroit announced it has reached a settlement with the insurers of the Unlimited Tax (UT) G.O. bonds, namely Ambac, MBIA’s National Public Finance Guarantee Inc. and Assured Guaranty.
Based on our first read, it would appear the insurers have scored a major victory: under the settlement agreement, the UT G.O.s’ claim will be reinstated at their current terms in the amount of $287.5 million, or 74% of the original par amount. In other words, the recovery rate on the UT G.O. bonds has gone from 15 cents on the dollar to 74 cents. The remaining 26% will go to establish an income stabilization fund to insure that “the most vulnerable retirees remain above the Federal Poverty Line.
Most importantly, the bond insurers, and hopefully the rest of the market, appear to have learned valuable lessons from the Detroit bankruptcy process. The confirmation order for the proposed settlement reads like a recipe on “how to best secure your UT G.O. bonds in a post-Detroit world,” to wit: (1) confirm the existence of a lien on ad valorem tax revenues and (2) find that the UT G.O.s millage constitutes special revenues under Section 902 of the Bankruptcy Code. As we’ve heard bankruptcy attorneys reiterate again and again, having a statutory lien on a defined tax revenue stream is infinitely preferable to relying on a simple full faith and credit pledge.
Thus, in one fell swoop, [Detroit’s] UT G.O. bonds … have now been kicked up to secured status with a recovery rate much more in line with historical experience.
And there’s more: on top of the initial millage proceeds already pledged to the original UT G.O. bonds, the new reinstated bonds will also benefit from a fourth lien on distributable state aid (DSA) and be considered pari passu with the City’s Distributable State Aid Second Lien Bonds, which have always been viewed as “secured.” Last but not least, the reinstated UT G.O. bonds will also be conferred “Most Favored Nations” (MFN) status, meaning that no other impaired unsecured (or deemed unsecured) class will be allowed to have a higher recovery rate.
Thus, in one fell swoop, the UT G.O. bonds which, just a few weeks ago, were staring at an abysmal recovery rate as unsecured debt, have now been kicked up to secured status with a recovery rate much more in line with historical experience. Moreover, they will now be clearly considered “senior” to any Limited Tax G.O. bonds. Although it will be the insurers, not the bondholders, who will reap the benefits of the proposed settlement, to have the UT G.O. pledge upheld as “secured” still constitutes a huge victory for the market as a whole. In truth, the opposite scenario would have established quite a disastrous legal precedent, so we have, in fact, dodged another major bullet.
As Detroit starts to fade from the headlines (at least we hope so), another potential G.O. disaster is looming on the horizon. The City of North Las Vegas, the only one among the top 100 most populous cities in the country to be rated below-investment grade, is threatening insolvency as its property tax base and casino industry have failed to recover from the Great Recession. Since Nevada doesn’t allow local bankruptcies, the potential exists for some kind of receivership by the State should the City become insolvent. City officials are also threatening to make bondholders “share in any sacrifices”. With PIMCO listed a major bondholder, one shouldn’t be surprised to see North Las Vegas in the media headlines for weeks to come.
It’s true what they say: never a dull moment in munis.
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