Bloomberg News

Muni Borrowing in 2012 May Rise 20% as Yields Sink, DeGroot Says

December 09, 2011

Nov. 25 (Bloomberg) -- Municipal borrowers may sell 20 percent more long-term debt next year compared with 2011 as yields sink to near historic lows, according to Peter DeGroot, head of municipal research at JPMorgan Chase & Co. in New York.

As much as $350 billion of bonds maturing in more than 12 months may be sold in 2012, compared with $291 billion projected for this year, DeGroot and Josh Rudolph, an associate, said in a note to investors. Rates on tax-exempt debt will decline in the first quarter and remain low into the second, while rising by year-end, he said.

“We believe the past year’s focus on default risk and bankruptcies is a bit off the mark,” DeGroot and Rudolph said in the report, sent today. “General-obligation credit has two key exposures to the economic cycle: tax revenues and pension funding. Neither of the two are expected to deteriorate enough to broadly threaten ability to pay.”

In the first quarter of next year, yields on tax-exempt securities will fall by 20 basis points, or 0.2 percentage point, for five-year maturities to 35 basis points on 10-year and 40 basis points for 30-year debt, according to the report. By the end of December 2012, the analysts said yields will rise on five-year bonds by 30 basis points and 55 basis points for 30-year issues. A basis point is 0.01 percentage point.

‘Key Risks’

“There are two key risks to our relatively sanguine view towards state and local government credit,” the analysts said. “First is the unpredictable behavioral response of both investors and issuers to the negative headlines surrounding outlier credits. Second is the economic response to fiscal consolidation needed at the federal level.”

Debt issued by states and local governments with a “high dependency” on federal defense spending and grants may be affected by the prospects of automatic U.S. budget cuts, they said. The failure this week of the congressional supercommittee to offer a federal deficit-reduction plan set in motion the so- called sequestration process that targets Pentagon spending and nonentitlement programs with cuts that may begin in 2013.

“On balance in 2012, the municipal market will face higher than typical headline risk associated with both domestic and global policy events will promote abrupt shifts in capital from risky to safe harbor assets,” the analysts said.

The prediction for an increase in municipal issuance, while still trailing the 10-year average by 15 percent, tops the $310 billion estimated by George Friedlander, senior municipal-bond strategist at Citigroup Inc. Friedlander made the prediction during a panel discussion at a Bloomberg Link conference earlier this month in New York.

General-Obligation Outlook

DeGroot and Rudolph said they expect general-obligation issuance to increase to $112 billion next year from $95 billion in 2011. The predicted amount is less than in previous years, the analysts said, citing “reluctance on the part of issuers to borrow in the more restrictive fiscal climate.”

Top-rated tax-exempt bonds maturing in 30 years yielded 137.7 percent of equivalent Treasuries as of Nov. 23, the most since April 15, 2009, according to data compiled by Bloomberg. The securities have returned about 9.1 percent this year through Nov. 23, compared with almost 9.7 percent for comparable Treasuries, according to Bank of America Merrill Lynch indexes tracking price changes and interest payments.

Through September, there were 42 defaults totaling $949 million, down from 79 valued at about $2.89 billion in the first nine months of 2010, according to Richard Lehmann, publisher of the Distressed Debt Securities Newsletter in Miami Lakes, Florida.

DeGroot and Rudolph called that amount “muted” and said they expect a similar level in 2012. That contrasts with the view from Meredith Whitney, the banking analyst who in a Dec. 19 broadcast of CBS Corp.’s “60 Minutes” show predicted “hundreds of billions of dollars” of defaults in 2011.

--Editors: Ted Bunker, Jerry Hart.

To contact the reporter on this story: Esmé E. Deprez in New York at edeprez@bloomberg.net;

To contact the editor responsible for this story: William Glasgall at wglasgall@bloomberg.net


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