The Mechanics of Finance: Municipal Finance

8/14/2019 The Mechanics of Finance: Municipal Finance

1/13

M I L K E N I N S T I T U T E C E N T E R F O R F I N A N C I A L M A R K E T S -

N AT I O N A L P R E S S F O U N D AT I O N

T U E S D AY, N O V E M B E R 1 2 , 2 0 1 3

Mechanics of Finance: Municipal Finance


2/13

Historical Interest Rate Yield: 2008-2013

Data Source: Bloomberg

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

Yield(%)

10 Year UST 10 Year AAA

Sep 2008

Lehman Bros. BankruptcyFannie Mae and Freddie Mac

conservatorship

Treasury guarantees money market

mutual fundFeb 2009

Financial Stability Plan announced

Recovery ACT signed

Jul 2010

Dodd-Frank ACT signed into law

TARP investment authority reduced

and limited to existing programs

May 2013

Bernanke discusses tapering

July 2009

QE1 expanded

Sep 2011

Operation Twist

announced

Mar 2010

QE1 ends

Apr 2012Italian and Spanish

bond yields spike

Jul 2011

QE2 endsNov 2010

QE2 announced


3/13

Muni Bonds: Where we are now

Source: Morgan Stanley - Municipal Bond Monthly Oct 2013


4/13

Muni Bonds Holders

Data Source: Q2 2013 Flow of Funds, Fidelity Capital Markets

Households are the largest holders of municipal bonds Households include farm households, domestic

hedge funds, private equity funds, and personal trusts(pension account)

Excludes bonds owned indirectly, such as throughmutual funds, which hold about $528 billion

The trend is gradually changing Mutual funds and commercial banks are increasing

their presence in this market0200

400

600

800

1000

1200

1400

1600

1800

2000

2008 2009 2010 2011 2012TotalOutstand

ingDebtHeld($Billions)

Households Commerc ial B anks Insurance Companie s

Money Market Funds Mutual Funds

Households

44%

Commercial

Banks

11%

Insurance

Companies12%

Money Market

Funds

8%

Mutual Funds

17%

Closed-end

Funds

2%

Foreign Holdings2%

Brokers and

Dealers

1% Other

3%


5/13

Muni Bond Issuance

Data Source: SIFMA

Municipal bond issuance is far below the 2010 levels Majority of municipal market is composed of revenue

bonds

0%

10%

20%

30%

40%

50%

60%

70%

80%

0

50

100

150

200

250

300

350

400

450

500

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013YTD

in

$bn

GO Revenue Private Placement

Revenue bonds as a percentage

of total issuance


6/13

New-Issue Supply

Data Source: SIFMA

New dollar issuance New Issue supply in 2013 YTD ($251.1 bn) is at nearly 60% of what it was during itspeak in 2010 which reflects ongoing austerity measures at both the state and local levels

Overall, refunding and maturities continue to marginally outweigh the new money supply in 2013, creating aslightly net negative supply environment

185221

287

228201

288

358383

360

408387

429390

410433

295

379

251.1

0%

10%

20%

30%

40%

50%

60%

70%

0

50

100

150

200

250

300

350

400

450

500

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013YTD

in$bn

Total Municipal Issuance Refunding as % of Total Issuance


7/13

Current State: Muni Finance

Source: Blackrock - Municipal Market Myths and Realities Aug 2013


8/13

Funded Ratios of State Public Pension Plans

Source: taxfoundations.org/maps


9/13

Credit Profile

Source: Janney Fixed Income Strategy State Fiscal Health Update Oct 2013Source: BlackrockMunicipal Market Myths and Realities

Most U.S. State credit profiles are strong, but therehas been select deterioration

States are keeping their debt levels relatively flat

Municipals exhibit high credit quality versuscorporates bonds


10/13

Tax Treatment

Source: Janney Fixed Income Strategy Muni Tax Considerations Aug 2013

As discount increases, the gap between YTM and After Tax Yield grows With the recent uptick in the interest rates, tax considerations have become more important

than ever Increase in yields is leading to a fall in after tax yields for muni bonds


11/13

Challenges: State

Source: Standard &Poors

Removal of Muni Bond Interestaffects Municipalities Repeal in tax credit could affect

creditworthiness of at riskmunicipalities

State Funding Status According to reports by Center on Budget and

Policy Priorities, states have been forced to close$593bn in budget gaps from FY 2009 to FY2013

Largest gaps were closed by huge tax hikes in CA,CT, IL and MA netting $23.9bn in FY 2010

Unprecedented spending decline of 3.8% and 6.3%in FY 2009 and FY2010


12/13

Challenges: Detroit

Source: Detroit Free Press


13/13

Challenges: Puerto Rico

0

10

20

30

40

50

60

70

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

($billion)

GNI, Atlas method (current US$) Public Debt

103% of GNI

Data Source: World Bank and Government Development Bank of Puerto Rico; Moodys Analytics

Trade volume of Puerto Rican bonds increased to$20bn from an average of $3bn-$5bn sinceSeptember

75 percent of muni bond funds own Puerto Ricobonds (Morningstar funds)

Commonwealth of Puerto Rico has not balancedits budget in twelve years Annual deficit financing has caused the islands

debt-to-GNI ratio to rise. In 2010, it was 109%,compared to 64.8% in 2000

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The Mechanics of Finance: Municipal Finance