Munis: Finding Value Post Detroit Bankruptcy
- Thursday, 08/22/2013
Watch my latest video which focuses on:
- Finding value in municipals now
- Securities Industry and Financial Markets Association's (SIFMA) letter to the Michigan governor on general obligation (GO) bonds
- Market outlook for second half of 2013
Value in Municipals Now
Recently, and this is going back over the last two months, there's been significant headline risk in fixed-income and the markets in general — beginning with Bernanke's comments about federal reserve tapering come the end of the third quarter of this year, as well as the bankruptcy filing of the city of Detroit. This has produced some dislocation in the municipal marketplace but it has also created some opportunity.
Over the last 9 to 12 months, interest rates in the muni market have risen anywhere from one to one and a half percent, meaning that there are terrific entry-point opportunities in the marketplace now that had not existed in the better part of two, two and a half years.
You might ask yourself where on the curve, or what kind of credits should I be interested in? Generally speaking, the intermediate part of the municipal yield curve remains very steep and it remains a point of opportunity, in my view, for anybody thinking about a new spot, or a new time to invest in the municipal marketplace.
The ETFs that are managed by Market Vectors encompass the entire spectrum of investment-grade credits. With some of the better opportunities currently in the A-rated and triple-B rated parts of the credit spectrum, you can be certain that the ETFs Market Vectors manages also encompass these types of opportunities.
SIFMA's Letter to the Michigan Governor on GO Bonds
As you know, the city of Detroit declared bankruptcy in the middle of July. The emergency manager that has been installed by the governor of the state of Michigan made some comments with regard to how he was going to proceed with negotiations to hopefully bring the city of Detroit out of bankruptcy. Included in some of those comments were representations about the standing of creditors, as well as bondholders, in terms of who was going to get paid and how they were going to get paid. This, amongst other comments made, raised some significant concerns amongst bondholders, as well as SIFMA.
SIFMA, and I'm going to read from their prepared statements which they sent to the governor of Michigan, was also very concerned about these comments. SIFMA said in their July 18th letter to Governor Rick Snyder, "SIFMA and its members feel investor trust and confidence in the capital markets is the cornerstone to the viability of the municipal market." And the key phrase, I think, in this letter, which they go on to mention later, goes like this: "Any action that would permit general obligation bonds to be treated on a pari passu basis with unsecured contractual obligations that are not backed by the full faith and credit pledge ignores appropriately the priority that should be given to these bonds."
What does that mean fundamentally? It means that in the construct of issues in the municipal marketplace, a $3.7 trillion industry rests on the back of that phrase, "full faith and credit pledge" of the issuers to make good on their obligation to pay the bonds. And if in fact, as Mr. [Kevyn] Orr [Detroit's emergency manager] would suggest, those bonds do not stand with the appropriate priority relative to other bonds issued, not only does that have serious implications with respect to bondholders for the city of Detroit and the community around Detroit itself, but other parts of the country as well in terms of this implicit promise that is used to build the municipal industry and general obligation bonds.
Second Half '13 Outlook
The remaining months of 2013 promise to be a compelling time, in part because we've gone through a significant upheaval in the municipal marketplace. We've seen redemptions occur in bond funds and exchange-traded funds. We have seen credit downgrades. We've seen the bankruptcy of Detroit. We've seen headline risk putting pressure on this marketplace and perhaps forcing a great deal more selling and more upward pressure on interest rates than would otherwise be brought to bear for this particular marketplace.
Yes, the Federal Reserve ultimately is going to be the determinant of where interest rates are going to go. But given the perspective that the economy is not in a robust state despite some modest gains that are made in employment, housing and other parts of the economy, there's really no reason to expect that interest rates are going to rise again dramatically from here, without some sort of outside agent affecting the direction of the markets.
My expectation is that this is a good entry point for investors for munis. We may have seen or we may be close to near-term highs in terms of recent rate moves on the upside. Fundamentally, there are great opportunities for picking up value that haven't existed for the better part of two years. Whether you're an intermediate- or a short-term investor, there are compelling reasons to put your money to work in these markets now. Money market rates are still very, very low. The amount of money that you earn on a CD, a treasury bill or a money market fund is de minimus with respect to opportunities that I think exist for investors in the municipal market.
NOTE: The outcome of the bankruptcy and legal proceedings are uncertain and there is no guarantee of payment.