Bloomberg News

Citigroup Blames Volatility on Investors Fed Forgot: Muni Credit

June 10, 2011

June 10 (Bloomberg) -- Citigroup Inc. analysts say there’s something missing from the Federal Reserve’s tally of the municipal-bond market’s size: more than $700 billion of the securities were bought directly by individual investors.

The Fed’s quarterly figures, released yesterday, put the market at $2.9 trillion, 37 percent of which the central bank says is owned by households. Citigroup’s analysts George Friedlander, Mikhail Foux and Vikram Rai say individuals play an even larger role, holding half of a $3.7 trillion market that has been whipsawed by speculation about municipal defaults that is now starting to ebb.

“The instability in the muni market in late 2010 was exacerbated by individual investors becoming overly concerned about the fiscal strength of state and local governments,” Rai said in an e-mail after Citigroup’s report on the market was published on June 3. “Unsurprisingly, as credit fears abated, it resulted in lower volatility and a rally in the tax-exempt and taxable market.”

The municipal-bond market has been rebounding after tumbling 4.5 percent during the last three months of 2010 in its worst quarter since 1994.

The supply of new securities has dropped as debt-wary officials reduce borrowing and as rising tax collections are improving the outlook for the finances of states that have been wrestling with budget deficits for the past three years.

Looming Defaults

While banking analyst Meredith Whitney has garnered attention for warning about looming municipal defaults, the actual amount was only $605 million through April, down from $1.7 billion a year earlier, according to Distressed Debt Securities Newsletter. State revenue jumped 7.9 percent from September to December compared with a year earlier, the fastest pace since before home prices peaked in 2006, Census figures show.

“There’s some recognition that Armageddon isn’t just around the corner,” said Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC, where he helps oversee $7 billion in municipal bonds.

“The consequence of not having an avalanche of defaults during the first five months of 2011 and the fact that the economy has at least moved forward” has helped bring buyers back into the market, he said.

Borrowing Costs

The Bond Buyer 20 Index, a measure of borrowing costs on 20-year general-obligation debt, dropped for an eighth straight week, slipping 0.02 percentage points to 4.49 percent, down from as much as 5.4 percent on Jan. 20. The yields slid even as new bond sales surpassed $6 billion this week for the first time this year, a result of issuers, including New York City, taking advantage of lower borrowing costs.

Investors added about $274 million to U.S. municipal-bond mutual funds in the week through June 8 -- the first inflow since November -- Lipper US Fund Flows said yesterday.

The last net addition was the week ended Nov. 10. The yield on 10-year tax-exempts, at 2.57 percent, is the lowest since November, after reaching 3.48 percent in January, the highest since 2009, according to data compiled by Bloomberg.

The departure of money from mutual funds that invest in municipal securities had been spurred in part by questions about the safety of the debt. Analysts, credit-rating companies and investors said the concerns were misplaced, given the steps that municipalities will take to avoid a default that would lock them out of the markets they rely on for public-works projects and short-term loans.

Cities and counties may face fresh questions from investors as property-tax revenue slides and states cut back on aid payments, Joshua Zeitz, an analyst with MF Global Inc., said yesterday in a note to clients.

Underestimating Individuals

Citigroup’s analysts didn’t challenge the Federal Reserve’s data on holdings by institutional investors such as mutual funds and insurance companies, which can be gleaned from corporate filings and other outside data sources. Without similar information on households, the analysts say, the Fed had to guess.

By underestimating the market, they’ve also diminished the extent to which individuals dominate it, they said. Citigroup estimates individuals they held $1.8 trillion, or half, of the municipal bonds outstanding at the end of 2010, compared with about $1.1 trillion estimated by the Federal Reserve.

“We always believed that the influence of retail investors in the municipal market was understated,” Rai said.

The Federal Reserve said it’s looking into the discrepancy, said Susan Stawick, a spokeswoman.

Bigger Market

Based on a compilation of all the individual bonds that have been issued, Bloomberg data shows the size of the market at about $3.8 trillion.

Researchers at the Securities for Industry and Financial Markets Association, the Wall Street trade group, agree that the Fed’s figures underestimate the size of the market, said Michael Decker, co-head of its munis division.

Municipal Market Advisors Inc. analyst Matt Fabian said he has no reason to challenge Citigroup’s estimate and is unsure what the consequence of the revised size would be, except that it may give bondholders the leverage to block any attempt by Congress to strip the securities of their federal tax-exempt status.

“The muni market has a long history of working with data that carries caveats,” he said. “We’re used to data that is somehow not just what we’d like. So the Fed data is more of that.”

Following are descriptions of pending sales of U.S. municipal debt:

NEW YORK STATE THRUWAY AUTHORITY, which oversees 570 miles of roads, is set to sell $408.8 million of revenue bonds as soon as next week. The securities are backed by payments from the agency’s highway and bridge trust fund. Underwriting of the offer is being led by Citigroup and Ramirez & Co. (Added June 10)

PRINCETON UNIVERSITY, the third-richest U.S. college, plans to invite bids on the sale of $275 million of bonds on June 15, using proceeds to finance capital projects at its main campus in Princeton, New Jersey, as well as at a satellite campus and administrative building. The bonds will be sold through the New Jersey Educational Facilities Authority. The college is rated Aaa by Moody’s Investors Service and AAA by Standard & Poor’s. (Added June 10)

--With assistance from Michael McDonald in Boston. Editors: Walid El-Gabry, Ted Bunker

To contact the reporter on this story: William Selway in Washington at

To contact the editor responsible for this story: Mark Tannenbaum at

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