Wednesday, October 14, 2009

Municipal Bonds: As clumsy as it is stupid

Municipal bonds are getting crushed again today. 10-year MMD was cut 13bps today after being cut 11bps yesterday. That's something like -2 points in price losses in two days. Closed-end funds are getting absolutely crushed. Traders I've talked to are blaming street selling. Here's what's been happening.

For weeks, the bid for munis seemed endless. Even as the ratio with Treasury bonds hit historic low levels, (75% on 10's) mutual fund flows were so strong and new issuance was so light that dealers couldn't keep bonds in stock. So they bid every competitive deal like a Correlian smuggler hitting on an Alderaanian princess.

Then all of a sudden the street found the level at which people just wouldn't buy. I'm not sure if fund flows have tapered off or if its just a buyers strike, but my bet is on the former. Now dealers are stuck with bonds in syndicate. If you are a dealer like Stone & Youngberg or R.W. Baird or Loop Capital (i.e., the regionals who are mainstays of the muni market) getting stuck with $20 million bonds really does matter to you. That's real capital that isn't making you any money. In fact, if you have to cheapen up your offering, it costs you money. You're taking losses on those bonds.

In other muni news, today we got two interesting BAB deals. The Crimson Tide vs. the Minutemen. Wouldn't be much of a match on the football field, and wasn't much of a match in the muni market either. University of Alabama brought a 2039 maturity (among others) with initial talk in the +220 area (that's 2.2% above 30-year Treasuries in yield). UMASS was talking +225 for the same maturity. 'Bama is rated Aa3/AA- while UMASS is rated Aa3/A+. Not really any difference.

Citigroup struggled to sell UMASS, even cheapening it up by 10bps. As I'm writing this, I don't believe the deal is done yet, after two days of selling it. Meanwhile Morgan Keegan had a food fight on their hands. Investors clamored for 'Bama, causing Keegan to tighten the bonds by 15bps. Many times over-subscribed.

So in the final analysis UMASS had to pay at least 30bps more in yield to sell their bond compared to University of Alabama. Why? Because no one trusts Massachusetts' budget. Note to politicians around the country. Your actions have consequences. That's real money UMASS is going to pay to bond holders instead of using it for education.

Finally, I heard today that the Nuveen Insured Dividend Advantage Fund (closed end) is selling $100 million of $10 par preferreds. This is intended to replace some of their existing auction-rate preferred bonds which have been stuck in limbo for nearly two years. Worth noting that its structured as fixed rate at 3% for 5-years (tax-exempt) with a premium call after 1-year. That's a hell of a rate! To my knowledge, CEF's never have sold fixed-rate preferred stock to fund their leverage in the past. It creates some risk that investment rates will fall below their leverage cost, but then again, they can call the damn things if they have to. If rates rise this thing would be a boon for the Nuveen fund. Look for all the closed-end funds to follow suit.

I think munis will come back, at least vs. Treasuries. We're now at a somewhat cheap 90% ratio on 10yr munis. I don't think anything has fundamentally changed and I don't think this sell-off has anything to do with credit fears. Problem is that it might be Treasury rates rising that gets the ratio back to 85% or so. Either way, I'm not going to jump in front of the train!

Disclosure: Bought the 'Bama bonds


Anonymous said...

Roll Tide!

John (Ad Orientem) said...

Al have you read John Jansen's closing summary on today's bond market?


GS751 said...

What do you mean by a 90% ratio?

Accrued Interest said...

Muni guys look at the ratio of Treasuries to munis. So if the muni rate is 4% and the Treasury is 5%, then the ratio is 80%. Around 80-85 is normal.

All-Mi-T [Thought Crime] Rawdawgbuffalo said...

so in other words the dollar is just ink and paper