The old reliable source to borrow money for "making money" has fallen on hard times.
t's a business cliché: "It takes money to make money." While state and local governments may not be profit-minded, they need revenue to stimulate their economies, create jobs and buttress their infrastructure — all of which will bring in more revenue.
The old reliable source for states and localities to borrow money for "making money" is the municipal bond market. But Old Reliable has fallen on hard times. For nearly two years — starting in early 2008 — the market has suffered "body blows," as J. Ben Watkins, puts it. Watkins, who heads up Florida's Division of Bond Finance and sits on the Government Finance Officers Association's debt committee, notes that, among the debacles were the collapse of the auction-rate securities market and of bond insurance companies. I talked to him recently about how states and localities were coping with the recent problems and what they were doing to get things back on track. Here are excerpts from that interview.
In the late winter of 2008, the auction-rate securities market collapsed. Issuers faced exorbitant penalty rates to keep their variable-rate bonds afloat. What steps are they taking to right things?
Many issuers had been living off the extraordinarily low, short-term interest rates of variable-rate bonds. These are bonds that have their interest rates reset at weekly auctions — so, you get lower rates but you take on the risk that those rates can go up. Now those issuers are on the flip side, experiencing a meltdown, and they've got to figure out how to fix it. Some have been able to refinance the debt with fixed-rate, long-term bonds, but not everyone has had access to the market. That's because the bond insurance companies that guaranteed their debt and conferred their triple-A rating on those credits, lost their triple-A rating — and you've got to have a triple-A rating to attract investors in variable-rate debt.
Two years ago, half of the bonds that came onto the market were insured by bond insurance companies. Now, with the big bond insurance companies of the business, less than 10 percent of the bonds coming to market are insured. How are issuers dealing with that?
Before the meltdown of the bond insurance companies, an A-rated bond could gain access to the market by wrapping the deal with the bond insurer's triple-A rating. That's no longer a viable option. In Florida, we handle all of the state's issuance — from government obligation (GO bonds) to lottery bonds to school bonds. The GOs, which are backed by the full faith and credit of the state, fly off the shelf. But it's more of a challenge for bonds rated below double-A. We just executed a revenue-bond deal for a parking garage for Florida International University — a credit backed by a mandatory student fee and not the full faith and credit pledge of the state. Normally, we would have sold this kind of bond with insurance. Now we can't. So where we used to sell everything on a competitive basis — we took bids and whoever provided the lowest interest rate won — we are using the negotiated sale, where we offer the bonds to a selected underwriter and negotiate the terms of the issue. When it's a credit that requires explanation, we'll more typically sell those on a negotiated basis. It's one of the ways we have adapted to the new world. It's also a fundamental shift in policy that's precipitated by the credit crisis.
In the 1990s there was a lot of controversy over "pay to play" for negotiated deals. Is that still a concern?
Rules were put in place to prevent "pay to play" and they have been effective. In general, though, there is more opportunity for other considerations to come into play when selling on a negotiated basis rather than on the lowest possible cost. But transparency is a great sanitizer. When you put all the detailed information out in the open, it has a salutary effect.
The Bond Buyer reported recently that November was the third strongest month of issuance in muni bond history and that 2009 is barreling towards a $400 billion year. What's the effect of that on you as an issuer?
I really expected credit to be tight this year but things have gotten progressively better. We're benefiting from the investors' flight to safety. A lot of money has been flowing into the muni space to be invested. So there's more liquidity and a lot more transactions are getting done. For a while during the year, it was mainly plain vanilla bonds, such as general obligation bonds, because the credit structure is so simple. It was a bifurcated market. Bonds down the credit spectrum, such as an A-rated housing or health care bond that's not as straightforward a credit as a GO, didn't have the same access to the market. Now the overall market is capitalizing on the flight to safety. Today we see a lot more transactions that are off the run — like housing or health care — getting done. And it's been a good market for issuers who had to fix problems with their auction-rate bonds. They can refinance them now at low fixed-rate rates.
What does the future look like?
We're going back to what the muni market was like 20 years ago — where we issue long-term, fixed-rate debt, where credit worthiness matters and so does financial management.
SUNSHINE CORNER
You'd have to be deaf and blind not to know that the unemployment rate slipped down to 10 percent in November. It's certainly no cure-all for what ails state and local revenues — or those without a job — but it's finally a move in the right direction. In addition to the downward trend in unemployment, there is, according to a Conference Board report, a positive move in employment. The Board's Employment Trends Index, which aggregates eight labor-market indicators, strengthened for the fourth consecutive month in November. "This month's large increase in the ETI suggests that job gains are imminent," said Gad Levanon, Associate Director for Macroeconomic Research at The Conference Board. That said, he didn't see that happening until the second half of 2010. Where are some other bright spots? According to the Institute for Supply Management, a reading of 41.2 over time in the manufacturing ISM index typically indicates an expansion of the overall economy. In November, the level of that index was 53.6, which economists see as consistent with continued growth in manufacturing output.
The latest Manpower Employment Outlook Survey reports that U.S. employers expect to increase their hiring plans in the first quarter of 2010 — only a moderate increase but an increase nonetheless.
Consumer confidence, according to the Conference Board Consumer Confidence Index showed slight signs of life in November — it rose to 49.5 percent from 48.7 percent the previous month. But, given that over the last 30 years, the index has averaged about 95 percent, it's not that much to get excited about: Consumers are still looking quite depressed but at least the direction of the mood has improved.
Retail sales, that ever-important indicator that the sales tax could respond, sent some mixed messages — most of them discouraging. However, the Retail Metrics and Thomson Reuters measures of in-store retail sales edged up in November, although both of those results were below expectations. An International Council of Shopping Centers post-Thanksgiving shopping survey showed that 42.2 percent of shoppers reported having completed their holiday spending, far below the 48.3 percent at the same point last year. This suggests, ICSC analysts say, that December sales could get an extra lift from the slower completion rate.
Consumer confidence is more than twice as strong as it was a year ago, according to the most recent results of theRBC Consumer Attitudes and Spending by Household Index. Driven by a strong upswing in expectations for the near-term economic future, the RBC Index for December 2009 stands at 39.0. A year ago, in December 2008, it stood at 15.3.
