Citi Says: Muni Market Reaches an Uneasy Equilibrium

George Friedland of Citi wrote: “The municipal bond market finally reached a resting point over the second half of last week, with yields actually declining modestly in some sectors. We cannot be confident that the worst is over until bond funds stop experiencing severe outflows. Nevertheless, a key component of the “feedback loop” that has pulled tax-exempt yields sharply higher — projections of widespread defaults and bankruptcies on local credit — will, we are confident, turn out to be vastly overstated, and, as the realization of this likely outcome takes hold in coming weeks and months, the fund outflows should decline and the muni market should reach a more lasting equilibrium, at the very least, or even rally fairly sharply.”

 

Up To His Hips in Muni Funds

One of Smith’s Cadre of Regulars was up to his knees in muni funds at the time he wrote me the note — but, it’s late in the day, so he is probably hip deep.

The muni closed-end funds are down 19.8% since their recent high on October 3, 2010. I think this is astonishing and way overdone but that doesn’t mean that they won’t go lower particularly on any day that Meredith Whitney is on TV or being heavily quoted in newspapers. In any case, here are the best values right now to my mind but whether these prices will hold is questionable. Please keep in mind that every fund is over-earning its dividend as reported in the UBS report that I circularized this morning. I have no idea what the catalyst is going to be to stabilize these funds let alone allow them to rise in price. Back in December, when tax-loss selling was at its worst, several of these funds yielded more than 9% so things could easily get worse. 

BFK, $11.47, 8.38% yield, 3.53% discount, A+ average quality

EIM, $10.57, 8.67% yield, 1.03% discount, AA+ quality – this is by far the worst performing fund

AFB, $12.23, 7.60% yield, 5.90% discount, AA+ quality

BLE, $12.30, 8.15% yield, 4.1% discount, A+ quality

KTF, $10.69, 7.86% yield, 4.6% discount, A+ quality

LEO, $7.20, 8.17% yield, 4.13% discount, A+ quality

MVT, $12.80, 8.3% yield, 1.3% discount, A+ quality

NMA, $12.42, 7.97% yield, 4.3% discount, AA- quality

NMO, $12.20, 8.02% yield, 0.49% discount, AA quality

PML, $9.52, 8.19% yield, 0.74% premium, A+ quality

VGM, $12.52, 8.43% yield, 1.8% discount, A+ quality

VKI, $10.45, 8.38% yield, 3.7% discount, A+ quality

VKL, $10.37, 8.45% yield, 3.5% discount, A+ quality

VMO, $12.15, 8.49% yield, 0.55% discount, A+ quality

Unfortunately, I am knee deep in these (not surprising my muni background) and the average yield of what I own is 8.34%. Only one of the funds I mentioned above are heavy into tobacco bonds which I eschew.  That fund is PML which has 18% of its holdings in tobacco bonds.

Chapter 9 Is For Municipal Bankruptcy

 There is a lot of talk about municipal bankruptcy.  For the record, Chapter 9 of the U.S. bankruptcy code is expressly written for municipalities.   Under the terms of Chapter 9, municipalities can restructure obligations – but cannot renege on the payments – so it is like a bankruptcy for an ongoing concern in the corporate sector (chapter 11).   The talk in Washington and among some corporate bankruptcy law firms is to allow municipalities to renege on their obligations to pay contracts and provide services.  It is a dangerous concept, to be sure, and I suspect it is more smoke than fire. 

Pensions and Other Post Employment Benefits will be the fatal terrain in the coming battle.  We have seen how corporations have declared bankruptcy and jettisoned their pension obligations into the federal life raft entitled: Pension Benefit Guaranty.   As you probably already know, the PBG is underfunded (i.e. insolvent).  Municipalities do not have access to the PBG, currently.  However, I suspect the municipal workers will find themselves in the same leaky life raft as the airline workers and steel workers at the end of the day.

Bondholders should be paid on a timely basis.  In the event of widespread defaults, it will tend to be more technical in nature (timing issues related to revenue recognition and expense payments) and we will provide you with the recovery gradings.   There will be a lot of problems as the politicians restructure the public sector’s wage and benefit packages.

Guest Comment on Gov. Christie’s Diet Plan

Here is a comment from one of Smith’s Cadre of Regulars on Gov. Christie’s Education Cuts. 

There are too many people who like to shoot their mouths off or from the hip—and they don’t know Diddley! Christie has greater ambitions, unfortunately he will encounter the Santa Clause Effect.  Santa is the only big guy people like and trust.  Actually, when he comes under scrutiny with a demanding media he won’t be able to bully people. He talks tough, but it feels and appears to be so very highly political.  He had non-specific ideas just a basic concept of things and articulates them in ways that are simplistic  but sells in the media and  the land of ten second sound bites.  See, when he cut state school funding in NJ, it was a costs shift from the state to the locals which only worsened the disparity between the wealthier school districts and the poor ones. In towns like mine  which is a pretty good area  my property taxes increased—but our community can afford it.  Lesser communities may have to wrestle with choices ranging from academic programs  to extra curriculum activities.  Politically he can say he cut spending, but it came at the costs of impacting education for the children.  I just don’t see how that is such a great accomplishment.  And now he has a platform to advance his political career because everybody is patting him on the back.  His confidence has grown.  Do you remember the poor and non-descript campaign he ran?  He is a new man now beaming with confidence.