More than half of municipal bonds carried insurance before the 2008 credit-market collapse, creating an abundance of AAA rated debt. Its decline allows for more opportunities to find underrated credits and yield spread, said Jamie Iselin, head of municipal fixed income at New York- based Neuberger Berman (0008526D), which manages about $11 billion of munis.
Iselin also discussed tobacco bonds, the recalibration of 2010 and the use of proxies to capture value for today’s Bloomberg Brief: Municipal Market newsletter.
Q: Are you happy with the decline in the amount of bond insurance in the market?
A: We love that it’s gone. We want our clients to be paid for our ability to assess the relative value of a particular security.
That insurance model created a really commodity-like feel to the market. A bond would get downgraded two notches and the price wouldn’t move at all. The market just yawned. It shouldn’t, because the underlying credit is weakening.
Though yields are much lower right now than they’ve been in a while, the opportunity in the marketplace to find bonds that have a yield spread is as high as at any point in our careers.
Q: Do you think there’s any chance of a revival of the municipal bond-insurance industry?
A: You never want to say never, but the market is distrustful of it. Also, the ratings agencies have been really harsh. I mean, they downgraded Berkshire Hathaway. (BRK/A)
If they can’t maintain a AAA rating, what entity is going to commit the capital to the muni-insurance business to get a AAA rating? If there are some new entries into the marketplace, it’s going to be a AA insurer, which will really be there to help the single-As and the BBBs, which is what insurance was originally meant to be.
Q: What types of municipal bonds do you avoid?
A: Tobacco securitization. Although most of the rulings lately have gone in favor of the tobacco companies, handicapping litigation risk is a very difficult thing to do. It has created enormous volatility in that sector.
The yields are very enticing, but that’s not the type of instrument we want. It’s a risk that’s very difficult to quantify. On top of that, the government is trying to discourage smoking, so that’s a force going against you.
Q: What are your thoughts on the recalibration of municipal ratings in 2010 by Moody’s Investors Service and Fitch Ratings, which resulted in higher ratings for many issuers?
A: I think it’s fair to say not every credit deserved that move higher. In some credits, it has created a coiled-spring effect, where they didn’t deserve the upgrade in the first place. We were in the middle of a recession, their performance from an operational standpoint was declining, and yet they shifted local GOs up by a notch to three notches.
This coiled-spring concept sets some credits up for multi- notch downgrades. The concept of a “super downgrade” is very different than what market participants have been used to. In the old days, if a credit started to deteriorate a little bit, you went on a negative outlook, which then moved to a negative watch, which may or may not have meant a downgrade, depending on if the municipality got its act together.
Now you have a jump to default methodology instead of an incremental methodology. I think ratings volatility is going to be a much bigger deal for the marketplace going forward.
Q: Do you ever seek out proxy credits for large state or city issuers that have a lot of debt outstanding?
A: There’s a general-obligation credit that is coterminous with the city of Chicago called the Chicago Park District (28074MF). The city and Park District share the same tax base, but the district is only responsible for the parks and not broader and fiscally stressful services for which the city is responsible, making it a stronger credit.
It’s a mid-AA to high-AA credit, but it trades at spreads that are much wider than a credit of that fundamental strength and those ratings would suggest.
You do have to be careful about credits that are too closely linked to a state, though. If a state is having a lot of problems, the market has gotten better at punishing credits with a close link.
Q: Are you concerned about the proposed 28 percent cap on the tax-exempt benefits of municipal bonds from President Barack Obama’s budget proposal?
A: We think you have to pay attention to this stuff much more closely because of the political climate. It’s the wrong call just to dismiss it.
We view Washington as so gridlocked leading into this election cycle that any major change in tax policy prior to the election is extremely low probability. But you have the president’s proposal, and on the Republican side, several candidates have talked about tax simplification.
Q: Do you have concerns about disclosure in the municipal market?
A: Disclosure in the last five to 10 years has improved a lot, with these repositories like EMMA. Also, I think people try to compare muni disclosure with corporate disclosure.
If you’re talking about a GO credit, they have a tax base, they set a rate on the tax base, and you have a pretty good idea about how things are going to play out over the course of a year. A quarterly update on how that’s going is not going to tell you all that much. They don’t experience the same revenue volatility.
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