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A Brave New World: Changing Dynamics of the Municipal Market

Explore the evolving landscape of municipal finance, with discussions on investors, issuers, credit enhancement, the short-term market, and ratings. Gain insights from industry experts at the NFMA National Conference.

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A Brave New World: Changing Dynamics of the Municipal Market

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  1. A Brave New World: Changing Dynamics of the Municipal Market Speakers: Matt Fabian, Municipal Market Advisors Bob Muller, J.P. Morgan Jim Murphy, T. Rowe Price Moderator: Naomi Richman, Moody’s NFMA National Conference May 7, 2008

  2. Discussion Topics and Leaders • Investors - Murphy • Issuers - Muller • Credit Enhancement - Fabian • Short-Term Market - Muller • Ratings - Fabian

  3. Topic #1: InvestorsWho is Today’s Marginal Investor?

  4. Estimated Growth of the TOB Market Growth of the TOB Market ($million liabilities outstanding) Source: JP Morgan Estimate

  5. Long term and Short Term Supply Trends Source: Federal Reserve, The Bond Buyer

  6. Basis Breakdown Hurts “the Trade” Source: Citigroup

  7. Short Term Market: Increasing Demand, Less Supply Source: The Bond Buyer

  8. Topic #2: IssuersHow are Issuers Responding to Current Market Conditions?

  9. In 2007, muni issuers sold $102 billion in short-term paper and have averaged short-term sales of $96 billion since 2003 • Despite the headlines, issuers are unlikely to want to move to a 100% fixed rate market • But, can they still sell short-term debt in size? • Without the ARS market, how much bank capacity is available? Municipal Issuance Since 2003 ($ Thousands) ISSUERS Source: Bond Buyer 7

  10. Topic #3: Credit EnhancementWhat’s the value of credit enhancement?

  11. MMA: Leading Market Change Value of Credit Enhancement • Sharp downgrades of some financial guaranty ratings have devalued all financial guaranty ratings; there is no easy recovery • Value of bond insurance is now insurer by insurer, investor by investor—what do YOU believe? • MMA expects the insurers will need to keep raising money into 2009 as the crisis widens and rating models are adjusted • Optimism for the affected companies is not yet reasonable Connect with Municipal Market Advisors> www.mma-research.com > 978.287.0014

  12. Topic #4: Short-Term MarketWhat is the future of the short-term market?

  13. Auction rates are still at expensive levels… Spot SIFMA/1 Month LIBOR vs. 1 Month LIBOR SIFMA 7-Day Auction Rate Index Spread over SIFMA • (BPS) • 1M LIBOR • SIFMA / 1M LIBOR THESHORT-TERMMARKET Source: JPMorgan Source: JPMorgan and SIFMA 2

  14. …Although the immediate issuer cost savings incentive to fixing-out to long-term rates has declined • Cross-over buyers and retail investors looking to pick up yield have drove ARS rates down from the absurdly high numbers witnessed in January through March • After conversion costs, issuers may find that the current market is in equilibrium with long-term rates • Nevertheless, the ARS market is vulnerable to further exogenous shocks, such as additional insurer downgrades Thirty-Year BMA Compared to Median ARS Yields THESHORT-TERMMARKET Source: JPMorgan, US Fixed Income Markets Weekly, April 4 2008 3

  15. Upheaval in the TOB market and the potential for changes in 2(a)7 eligibility will be the next hurdles for the short-term market • JPMorgan estimates that the TOB market shrunk by 22% in 1Q08 • TOB drivers face margin calls due to a underperformance in the AAA curve relative to LIBOR • Increased credit scrutiny from money market funds • Decreased liquidity from banks • Multiple forces are converging on the 2(a)7 market that may make for big changes • Market will be shaped by MSRB, SEC, global ratings and bank capacity Growth of the TOB Market ($ Million Liabilities Outstanding) 20 Yr AAA / 20 YR LIBOR Ratio -22% THESHORT-TERMMARKET Source: JPMorgan estimates. Data as of April 2008. 4

  16. Tax-exempt money funds and bank deposits will likely see large inflows as taxable money funds lose attractive assets to invest in • The regulated and non-regulated banking system is heavily reliant “maturity transformation” • Two basic forms of maturity transformation in the non-regulated system are commercial paper issued by SIVs/conduits and repos from hedge funds • In addition to that are the maturity transformations done via the auction rate market, TOBs, VRDBs and broker-dealer issued securities Skeleton Balance Sheets and the Securitization Process THESHORT-TERMMARKET Source: JPMorgan, “How will the crisis change markets?”, April 14 2008 5

  17. Topic #5: RatingsHow can investors sort out the evolving meaning of bond ratings?

  18. MMA: Leading Market Change Corporate Equivalent Ratings for Munis (1 OF 2) • At this point, change is inevitable • Participants should be studying implications not alternatives • Trading “through” GSRs may not be feasible if TOBs re-emerge to suck out yield again • Creates a serious challenge for the bond insurers; Radian and Assured Guaranty perhaps best positioned • S&P’s position creates risk to the market that we will only have two new issue rating agencies going forward Connect with Municipal Market Advisors> www.mma-research.com > 978.287.0014

  19. MMA: Leading Market Change Corporate Equivalent Ratings for Munis (2 OF 2) Connect with Municipal Market Advisors> www.mma-research.com > 978.287.0014

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