Bloomberg News

Jefferson County May Rekindle Whitney Concerns, Schroeder Says

November 15, 2011

Nov. 10 (Bloomberg) -- The bankruptcy of Jefferson County, Alabama, may keep municipal yields that are already high relative to U.S. Treasuries elevated as some investors flee tax- exempt debt, according to Michael Schroeder, president and chief investment officer of Wasmer, Schroeder & Co.

The bankruptcy could spook some buyers after bank analyst Meredith Whitney last year predicted “hundreds of billions of dollars” of defaults in the municipal market, leading to an exodus from tax-exempt funds, Schroeder said. While her prediction failed to materialize, yields have stayed high relative to Treasuries, according to data compiled by Bloomberg.

This year through September, the number of municipal defaults fell to 42, totaling $949 million, from 79 in the first nine months of 2010, amounting to about $2.89 billion, according to the Distressed Debt Securities Newsletter, published by Miami Lakes, Florida-based Income Securities Advisor Inc.

“It does have some implications on a broader base for the market,” Schroeder, whose Naples, Florida-based firm manages about $3 billion of municipal bonds, said in an interview before the bankruptcy filing. Going back to the concerns Whitney expressed, “it shows how political municipal-credit analysis has become,” he said.

Premium to Treasuries

Benchmark municipal bonds have been trading above interest rates on similar-maturity U.S. Treasuries, with 10-year tax- exempt yields at almost 115 percent of those on federal debt, according to data compiled by Bloomberg. The ratio was 119 percent on Nov. 1, down from a 2011 high of 123 percent on Oct. 6, the data show. It has averaged almost 92 percent since 2001.

Yields on 10-year Treasury notes declined to 1.96 percent yesterday from 2.08 percent Nov. 8, according to Bloomberg Bond Trader prices. The yield on 10-year AAA municipal debt was 2.25 percent, down from 2.30 percent, BVAL data show.

“It’s a negative,” said Alan Schankel, director of fixed- income research for Janney Montgomery Scott LLC in Philadelphia. “I don’t think it’s a huge negative, but the sheer size and the headline number, about $3 billion in bonds, it can’t help but have some impact. I don’t think it will be huge because this has been going on for a long time.”

Municipal bankruptcies involving Central Falls, Rhode Island, in August and Harrisburg, Pennsylvania, last month haven’t prompted a flight from the $2.9 trillion local- government bond market, and yields have dropped to levels unseen since the 1960s. Returns on the securities including interest have tied Treasuries this year at 9 percent, according to Merrill Lynch Bank of America indexes, and beaten the 3.4 percent for the Standard & Poor’s 500 equity index, according to data compiled by Bloomberg.

‘Slow-Motion’ Wreck

“I’m sure there will be some people who want to dog the market and will use this as a center-stage example,” said Rob Novembre, managing director of Arbor Research & Trading Inc., a broker in New York. Investors will hardly be surprised, he said.

“The market has been more or less prepared for it,” Novembre said. “It’s been a slow-motion train wreck for the last three years. I don’t think it will come as a surprise as much as a disappointment.”

Investors may be more reluctant to buy from borrowers with exposure to derivatives because the Jefferson bankruptcy was linked to interest-rate swaps, which backfired when they were used in an attempt to lower the county’s cost of financing a sewer project, said John Donaldson, who oversees about $600 million of municipal assets for Haverford Trust in Radnor, Pennsylvania.

Risk Issue

“If anybody opens a new official statement and reads disclosure on derivatives that doesn’t read well, I think it will have an impact on somebody trying to come to market who’s got derivative exposure,” Donaldson said.

While significant, the bankruptcy shouldn’t reignite the kind of fears of defaults that gripped the market after Whitney’s statements on CBS Corp.’s “60 Minutes” show in December, said Justin Hoogendoorn, managing director in the strategic analytic group at BMO Capital Markets in Chicago

“The market understands that it’s not systemic,” he said. “It’s a headline so it could chase a little bit of retail money out of the sector, but beyond that I don’t think it’s too big of a problem for the market to absorb.”

--With reporting by Andrea Riquier and Michelle Kaske in New York. Editors: Ted Bunker, Pete Young.

To contact the reporter on this story: Michael McDonald in Boston at

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

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