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U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P Managing Municipal Debt in Today’s Market August 13-17, 2011 NASACT 2011 Conference.

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Presentation on theme: "U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P Managing Municipal Debt in Today’s Market August 13-17, 2011 NASACT 2011 Conference."— Presentation transcript:

1 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P Managing Municipal Debt in Today’s Market August 13-17, 2011 NASACT 2011 Conference Alex Wallace Managing Director U.S. Bancorp Municipal Securities Group

2 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 2 Municipal Issuance Municipal Supply* *2011 YTD 1/1 - 8/1 Tax-Exempt Rates Below Historical Averages* *Comparison of 8/11/2011 AAA MMD v. 10-yr Historical MMD averages 10yr MMD5yr MMD30yr MMD Source: TM3Source: SDC Municipal Issuance by Mode* *2011 YTD 1/1 - 8/1 Municipal Issuance by Market Access* *2011 YTD 1/1 - 8/1Source: SDC

3 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 3 Municipal Market Issues Coming into 2011 Legislative  Reinstatement of ARRA programs (temporarily or permanently)  Elimination of tax-exemption  Impacts of Dodd-Frank Wall Street Reform Act Potential Supply / Demand Imbalance  Expectation for overall lower volume in 2011  Outflows from municipal bond funds  Continuance of cross-over buyer support in the municipal market  Underperformance of municipal bonds versus other asset classes Interest Rate and Credit Spreads  Sustainability of low interest rate environment. Inflationary concerns looming  Tax-exempt and taxable relationship (i.e., ratio)  Credit spreads under pressure, especially for more storied credits Credit Differentiation  Investors and rating agencies are more focused on credit drivers, liquidity, and transactional risks  Emergence of headline risk and perception of defaults in the municipal market  Future of bond insurance  Issuer disclosure requirements Variable Rate Market  An estimated $112 billion in expiring Letters of Credit and Standby Bond Purchase Agreements in 2011  Outflows from tax-exempt money market funds  Impact of Basel III on banks’ ability to provide liquidity at acceptable prices  Floating rate alternatives (Direct Purchase, Floating Rate Notes, Put Bonds, etc)  Swap Exposure – estimated mark-to-markets of approximately negative $300 Billion

4 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P Municipal Issuance Source: Thompson Reuters Annual Municipal Issuance Volume (Jan. – June) Issuance by Methods (Billions) Market CommentaryIssuance by Rate Mode (Billions)  Year-to-date municipal issuance volume at a 10 year low  Municipal issuance is down 40% from 2010 levels  Approximately $142 billion of new debt has come to market this year in the public market  75% of all volume has been negotiated year-to-date  87% of year-to-date primary public market volume has been in fixed rate mode v. 7% in variable rate mode  Private market activity growing - Direct Purchases - Renewals - Remarketing Takeovers - Swap Novations

5 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 5 Municipal Defaults (7/2009 – 8/2011) SectorAll NoticesDefaultsReserve Fund Draws Par ($MM)# Trans.Par ($MM)# Trans.Par ($MM)# Trans. Land Secured4, , ,35286 Toll Road/ Transit4, ,4191 Tribal9404 4n/a IDB1, Housing Retirement2, Hotel Other “Risky” Sectors13, , ,31949 Safe Sectors*7, ,91018 Total$35,836614$8,719308$18, Initially Non-Rated$10,293433$5,947259$2, Initially Insured/ LOC Bonds$14,59586$6245$9,27148 Initially Rated/ Uninsured$10,11551$1,64018$6,84420 *GO/ Wtr/Swr/ Sales Tx Source: Municipal Market Advisors

6 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 6 Municipal Yield Curve Market Commentary Tax-Exempt MMD Yield Curves 7/1/2010 – 8/1/2011  Yield curve is historically steep – 2-30 year curve is over 400 basis points  Steep yield curve will drive financing structures and decisions made by our clients  Investor Segments - Short-term: MMF’s Corporations Banks - Intermediate: Intermediate Bond Funds Retail SMA’s - Long-term Bond Funds Insurance Companies Bank Trusts Hedge Funds (Arbs. / TOBs) Source: TM3 Short Term Long Term

7 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 7 Historic Long-Term Rates LONG TERM MARKET LONG TERM MARKET High Grade Municipal Index 30-yr Spot (Jan 1990 – Present) Sept., 15, 2008 Lehman Brothers Bankruptcy filing 20 year MMD Average MMD Historic Low 20 year UST Average UST Historic Low

8 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 8 Long-term Ratios: MMD and US Treasury  Ratios are an important factor in determining future tax-exempt rates and the sustainability of “cross-over buyers” 30yr MMD/UST Ratio Liquidity Crisis  ARS fail  Insurers lose AAA  Trading/ leveraged buyers exit market ARRA  BABs, QSCBs, etc.  AMT Holiday 85% 99% 143% 128% April 15, 2009: 1 st BAB Deal Jan. 1, 2011: ARRA Expires 107% August 1, 2011: 105%

9 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 9 Credit Spreads - Shorter duration - Current coupons not attractive - Use of web-based portals such as Buy___Bonds.com - Use of Mini-Bonds  Credit spreads have tightened but remain at historically high levels.  “Flight to quality” dynamics still exist  Limited exposure to A and BBB rated credits by investors  Retail participation remains a high priority for most issuers Municipal Credit Spreads Since January 2006 Source: TM3

10 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 10 Municipal Bond Fund Flows  Recent negative headlines in the municipal market led to substantial mutual fund cash outflows and increased secondary selling pressure. Tax-Exempt Bond Flows (Funds that Report Weekly) YTD 2011 $22bn Outflows Jan. 1, 2011

11 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 11 Historic Short-Term Rates LONG TERM MARKET LONG TERM MARKET Short Term Indices: SIFMA & LIBOR (Jan 1990 – Present)

12 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 12 Short-term Ratios: SIFMA and LIBOR  Ratios are an important factor in determining future tax-exempt rates and the sustainability of “cross-over buyers”  Influx of new cash from taxable money market funds – currently represent a significant increase in the number of assets available to purchase tax-exempt instruments  Daily resets are trading 10 basis points through SIFMA SIFMA v. LIBOR (Aug – July 2011)

13 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 13 Variable Rate Issuance Observations Money Market Fund Assets and Outstanding VRDNs  Variable rate funding continues to provide compelling cost advantages compared to fixed rate debt  Availability of credit enhancement continues to be an issue  Increasing distinction (i.e., trading spread) between lower and higher quality credit providers - Higher quality banks trading as much as 5bps through SIFMA - Lower quality banks trading as high as 20bps over SIFMA Cross-over Buyers Include:  Corporations  Taxable Funds  Foreign Banks  Hedge Funds  Insurance Companies Cross-over Buyers Include:  Corporations  Taxable Funds  Foreign Banks  Hedge Funds  Insurance Companies Crossover Buyers

14 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 14 Money Market Fund Flows Max MMF Assets: $528bn (8/19/08) MMF Assets Today: $301bn (7/26/11) Money Market Fund Assets and SIFMA

15 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 15 Municipal Market Credit Expirations Market Commentary Total Muni Credit Expirations 2011 and Beyond  Record volume of expiring bank credit facilities have not taxed the market as expected  Issuers have been successful in extending expiring credit facilities or restructuring outstanding VRDNs - Fixed Rate Bonds - Direct Placements - Floating Rate Notes Source: Bond Buyer

16 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 16 Alternative Structures Floating Rate Notes (FRN)  Public market issuance  Sold primarily to money market funds, short bond funds and insurance companies  Index: SIFMA or % LIBOR based  Up to 7 year term  Hard maturity preferred  No remarketing fees  Does not require bank enhancement  Eliminates trading risk volatility  Structure lends to Interest rate risk hedging options  YTD issuance approximately $5B Direct Purchase  Private market issuance  Principally purchased by commercial banks  Index: % LIBOR based  1-7 year initial mode  Soft Maturity negotiable  No remarketing fees  Eliminates trading risk volatility  Often customized to match existing swap rate structure to eliminate basis risk  YTD issuance estimated at $10B

17 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 17 Alternative Structures (cont’d) Synthetic Structures  Current rate environment attractive for hedging future issuances - Taxable rates have rallied tremendously relative to tax-exempt rates - Absolute tax-exempt levels remain historically low – Current MMD* approximately 116 basis points below twenty year average and almost 100 basis points below 6-months ago  MMD “cheap” relative to LIBOR - Approximately 3 standard deviations to the 6-month average As of 8/4/2011 Source: TM3

18 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 18 Impact of US Treasury Downgrade  Increased fears downgrade may force already fragile recovery into “double dip”  Initial market reaction counter-intuitive  “Flight-to-quality” to Treasuries (Despite downgrade, still seen as “safe”)  10yr Treasuries dropped to its lowest level since Jan  Long-term impact on municipal market unknown  Possibility credit spreads may widen  Certain sectors have already been affected and will remain under pressure  GARVEES  Housing Securities  Hospitals  Build America Bonds may be exposed to potential timing and subsidy-reduction risks  Increased uncertainty has dampened primary issuance to approximately $2.8B for the week, the slowest August week since 2003

19 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 19 Emerging Trends  Issuer confidence  Absolute rate levels  Ratios  Counterparty risks (credit enhancement, swaps, and remarketing)  Investor base dynamics (cross-buyers, money and bond fund flows)  Synchronizing disclosure in the public and private markets (especially on parity debt)  New product development  Basel III implementation  Issuers’ debt mix and methods of sale  Continued availability of alternative debt instruments  Floating Rate Notes  Direct Purchases  Put Bonds  Potential return of BABs?  Increases in municipal downgrades / defaults

20 U. S. B A N C O R P M U N I C I P A L S E C U R I T I E S G R O U P 20 Confidentiality and Disclaimer The material contained herein is confidential and may not be shared with parties without the express and prior written consent of U.S. Bancorp. It has been prepared for informational purposes only. It is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This is not a research report. This material summarizes publicly available material. This material was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Each taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor. Past performance is not necessarily a guide to future performance. This material is distributed to and intended for U.S. persons only. Please see additional important information and qualifications throughout this material, including information regarding the risks of derivatives such as decline in value, settlement risk or liquidity risk. All pricing is on an indication basis only and should not be construed as the terms of the contract as they are neither binding nor guaranteed. Pricing may change due to market forces of supply and demand. “US Bancorp” is the marketing name used by U.S. Bancorp and its subsidiaries including, U.S. Bank Municipal Securities Group and U.S. Bancorp Investments, Inc. Municipal products and services are available through U.S. Bank Municipal Securities Group and U.S. Bancorp Investments, Inc. U.S. Bank Municipal Securities Group is a separately identifiable division of U.S. Bank National Association and an affiliate of U.S. Bancorp Investments, Inc., member FINRA and SIPC. Investment products and services offered by U.S. Bank Municipal Securities Group and by US. Bancorp Investments, Inc are: Not a Deposit | Not FDIC Insured | Not Guaranteed by the Bank | May Lose Value | Not Insured by Any Federal Government Agency.


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