Thursday, December 04, 2008

Port Authority: You overconfidence is your weakness

The headline is that the Port Authority of New York/New Jersey got no bids on a $300 million municipal bond offering. Its distressing, yes. Its a clear sign of how dislocated the muni market is, yes. But the mainstream media is badly missing the most important aspect of this story. This was a problem entirely of the Port Authority's creation.

Alright, raise your hand if you've heard that liquidity is bad. Oh and raise your hand if you've heard that broker/dealers are capital constrained. Also raise your hand if you've heard that the municipal market is dislocated. Is that everyone? Every person who reads Accrued Interest is well aware of the problems in this market, I'm sure. Keep that in mind as you read the following.

The Port Authority was attempting to sell taxable municipal bonds, which is to the municipal market what the Gungans were to the Naboo. Taxable municipals, while potentially great investments, don't have the natural buyers that tax-exempts (e.g., mutual funds) that tax-exempt bonds do. Taxable munis should trade like high-quality corporate bonds, but tend to be much less liquid, even in good times. $300 million is a lot for any municipal deal, but its a humongous size for a taxable municipal deal.

Next, the Authority tried to do this sale competitively. Basically there are two ways municipalities come to market. One is a negotiated deal, where the issuer hires an investment bank ahead of time. The bank agrees to buy the debt from the issuer and resell it to the public. In a competitive deal, investment banks are invited to bid on the issue. The highest bidder then buys the bonds from the issuer and resells them to the public.

In a negotiated deal, the investment bank has time to work the bonds. The salesforce knows its their deal to sell, so they are more motivated to sell it. In a competitive deal, the salesforce usually only has a hour or two, and if their firm's bid isn't the winning bid, the salesforce has wasted their time. In addition, a competitive deal requires the winning investment bank to immediately and unconditionally buy the deal from the issuer. In other words, commit capital.

So when a competitive deal comes along, what's Wall Street going to do? They are completely unwilling to commit capital to something as low-margin as municipal bonds. So they are going to only bid if they have the deal pre-sold. This has been the case for several months, but has never been more true than right now.

Now if you and I know all this, then surely a big municipal authority like the Port Authority must know all this. And even if they don't, then clearly their financial advisor must know all this, after all, that's what the FA gets paid for. And yet, knowing all of the above, they decide to go forward with a $300 million competitive deal. They decide that Wall Street should cow to their every bond issuing whim. Perhaps they figure that Wall Street takes the PATH trains into Manhattan in the morning, they must be dying to buy Port Authority bonds!

The fact is that the investment community isn't dying to buy anything! Even the TGLP bonds are being sold over a period of multiple days. And those are 100% full faith and credit! The Port Authority apparently scoffed at this fact. Surely investors would scarf up their bonds in mere hours! Right?

I know at least two large Wall Street firms had over $100 million in orders, but couldn't get to the $300 million number before the bids were due. So guess what? They didn't bid. It wasn't that there was anything wrong with the Authority's credit. It was that the Authority decided to pursue a perfectly stupid means of raising cash.

Why did the Authority need $300 million right now? If they had done a $75 million competitive deal, they would have had no problems. They could have done another in 3-4 months. And another a couple months after that. Or they could have done the deal negotiated. Given their bankers time to convince the big whales that 3-year Port Authority bonds at +375 was a great deal. I'm telling you, it would have worked.

But instead, the Authority assumed they were endowed by their maker with the right to foist bonds onto Wall Street. Instead of paying attention to market conditions, the Authority pretended like it was business as usual. Instead of following a sensible strategy for raising cash in a liquidity-challenged environment, the Authority displayed a foolhardy level of arrogance.

And what did they get in return? A lot of egg on their face.


Gringcorp said...

I always wondered whether the Port Authority had as bad a reputation with investors as it had with the contracting community and media. Maybe it didn't - until now.

You said...

See Hawaii had no problem selling over 277 million worth of bonds to small investors. Some taxable too..
bite size pieces easier to swallow in this market, which tends to make anything larger than a moneyclip make you want to puke.

TH said...

Why wouldn't an investment bank submit bids when they know that any of the bonds they are stuck with could be repo-ed to the Fed? Are taxable munis not considered an acceptable form of collateral? Does the swap not make sense? I understand not wanting to commit precious capital right now, but that seems like a no brainer to me.

Aurelien said...

This question is a bit off topic, but I couldn't find a palce to email you directly.

I found out yesterday that some Sears bonds are selling at 37 cents on the dollar with a 20% yield. Im interested in purchasing a couple of these bonds, but am having problems figuring out how. I'm a small investor that would only be buying a minimal quantity. Do you know of any brokerage firms that specialize in bonds which would have reasonable commisions?

Also, do you know of any good corporate bond blogs? My search on google only found a couple that haven't been updated recently.

Thanks alot for any info!

Unknown said...

Excellent synopsis. Taxable munis dont have a natural buyer, and for all the other reasons you pointed out - the entire process was flawed.

Accrued Interest said...


I think the biggest problem is a lack of term funding. If you knew you could borrow at a fixed rate for the 3-year term of the Port bond, that would be one thing. But that isn't the situation. You borrow short and lend long. What happens if the short funding gets taken away? What happens if the mark to market goes against you?


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TH said...


True, but if the Fed is your creditor, it seems reasonable to assume they won't collapse the PDCF or whatever lending facility you could repo the Port bonds through until credit markets conditions are much more favorable than they are now. Risk of your funding being cut off seems low. Plus, couldn't you sell CDs or FDIC backed corporates to make money off the repo while you wait.

TH said...

In related news, JPM brought a $300 million NYC deal today for retail that is way, way too expensive compared to NYC in the secondary market right now. I'm hearing that it was pushed extremely hard on the salesman, market conditions be damned. Anyone how the sale is going?

Unknown said...

Perhaps, Port Authority wanted this to fail in a believable way to make it easier to claim hardship so they can cut service and raise fares.

capitalhill said...

Who was the FA on the PANY/NJ deal?

Jeane said...

Very helpful info, thank you for your article.