Municipal Bonds: Finding Value Through Credit Analysis
Presented by: Drew Simmons, Vice President [email protected]
Relative Value - Sector Spreads: 2000 - Today
Muni
MBS
AGY
Finding Value Through Credit Analysis Municipal Market Review
Finding Value Through Credit Analysis Municipal Market Review (continued)
Finding Value Through Credit Analysis Muni vs. Treasury When Rates Rise
64%
32% 51%
42% 41%
36%
Average Muni Sensitivity to TSY 44% 10Yr Treasury
10Yr AAA BQ Muni
Finding Value Through Credit Analysis Muni vs. Treasury Regression
A regression analysis of 10yr Treasury yields and 10yr Municipal yields shows Municipal yields rise only a fraction of Treasury yields. The top left chart shows that during the 1993-2007 time period, when Treasury yields move 100bp, Municipal yields move just 61bp. It also shows that this was a relatively “tight” relationship. The bottom chart at left shows that since 2007, that relationship has been inconsistent and less reliable, but still shows Municipal yields moving much less than Treasury yields.
Finding Value Through Credit Analysis Municipal Defaults – The Next Crisis?
“You could see fifty to a hundred sizable defaults, more. This will amount to hundreds of billions of dollars’ worth of defaults [within 12 months].”
Meredith Whitney “60 Minutes” December 19th, 2010
Finding Value Through Credit Analysis Municipal Default Update
. Volume Defaults spiked in Q4 ’11 while nominal defaults were muted
. Most of the Defaults in 2011 were non- traditional municipalities (e.g. American Airlines BK, Tobacco Corps)
Finding Value Through Credit Analysis
Municipal Defaults Are Rare
Defaults 07-11 By Type Defaults 2007-11 By Tax Status Other G.O. BQ Taxable AMT Special 5% 1% 2% 5% 9% Assessment 16%
NBQ Revenue 84% 78%
Finding Value Through Credit Analysis State GO Ratings and Pension Status
Finding Value Through Credit Analysis Municipal Bankruptcy
. Of the 300+ BK filings over the past 40yrs, bond investors were repaid in full, sometimes late, but made whole.
Source: Chicago FED, “Tempestuous municipal debt markets: Oxymoron or new reality?” Oct. 2011 Finding Value Through Credit Analysis Municipal Tax Collections
Source: Moody’s U.S. Municipal Bond Defaults and Recoveries, 1970-2011 March 7 2012
Finding Value Through Credit Analysis City Revenue Changes in 2011
Finding Value Through Credit Analysis City Spending Changes in 2011
Finding Value Through Credit Analysis Municipal Transparency Very Weak
2005-2009 Delinquent Filings 19% of issuers have NEVER filed Current 43% 56% of issuers are 1 or more years delinquent 5yrs 19% 1yr 15% 4yrs In 2009, 72% of all financials were 3yrs 2yrs 9% more than 2 year old 6% 8%
% of Issues 3+ Years Delinquent by ST
90.00% 80.00% Average filing time is 228 70.00% 60.00% days after fiscal year-end 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% Source: DPC DATA Inc., “Recent Trends in Municipal Continuing WY VT ME MT ID SD UT NE AK IA OK DE VA ND LA MS AZ Disclosure Activities”, February 3rd, 2011 Finding Value Through Credit Analysis The Credit Analysis Process
. Implement a “Robust Credit Risk Assessment System” . Pre-Purchase & Post-Purchase Analysis . Ability to Repay, Demographics, Financial Condition . Specific Attention to Non-Rated, Non-Insured bonds Pre- Post- Purchase Justify Purchase Purchase Decision Position Analysis Analysis
Defaults mostly coming from smaller issuers Defaults mostly coming from non-rated (NR) securities
Finding Value Through Credit Analysis Regulatory Focus: Municipal Bonds
“if a bank has a high concentration of municipal bonds relative to their capital, they better dazzle me with credit analysis” …FDIC Capital Markets Examiner
. Understand Your Municipal Concentration • Munis as a % of Capital – There is no specific threshold • Special focus: less than A-Rated, Non-Rated, Revenue Bonds
. Perform Thorough Pre/Post Purchase Credit Analysis • Understand What You Own & Know Your Credits • Access & Review Financial Statements • Develop Specific Credit Criteria & Monitor Regularly Municipal Credit Reports Credit Profile Sheets
Finding Value Through Credit Analysis Regulatory Changes: Dodd-Frank
http://www.occ.gov/news-issuances/news-releases/2011/nr-occ-2011-140b.pdf
. OCC NPRM, November 2011: . “The definition of investment grade in 12 CFR Part 1 to no longer include reference to credit ratings”
. “Consideration of internal analyses, third party research, and analytics including external credit ratings, internal risk ratings, default statistics, and other sources of information”
. Having a “Robust Risk Management Framework”
. "Risk measurement should be obtained from sources independent of sellers or counterparties and should be periodically reviewed“
The key word here is Risk Measurement, meaning the internal procedure, NOT the data itself. Finding Value Through Credit Analysis OCC: Risk Management Framework
Finding Value Through Credit Analysis Municipal Bond Concentration
“if a bank has a high Municipals / Tier 1 Capital concentration of municipal Q4 2011 bonds relative to their Q3 2011 Q2 2011 capital, they better dazzle Q1 2011 Q4 2010 me with credit analysis” Q3 2010 …FDIC Capital Markets Examiner Q2 2010 Q1 2010 Q4 2009 Q3 2009 Q2 2009 . Q1 2009 Buying a municipal bond Q4 2008 should be viewed in the Q3 2008 Q2 2008 same manner as making Q1 2008 Q4 2007 a loan. Pre- and post- Q3 2007 Q2 2007 purchase credit analysis Q1 2007 is just as important. 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8
Finding Value Through Credit Analysis Municipal Credit Checklist
. Understand Your Exposure . Municipal Holdings as a % of Capital – There is no specific threshold . Geographic Concentration . Tax Status, Issue Type, Revenue Source, etc. . Implement Credit Metric Benchmarks . Develop credit criteria as part of you investment policy and/or strategy . Justify metrics that are out of benchmark when appropriate . Document areas of concern . Proof of an Established Credit Analysis Process . Pre-Purchase Documentation: Credit Profile Sheets, Financial Statements, OS . Evidence of a meaningful Post Purchase Review Process
Finding Value Through Credit Analysis Understand Your Exposure
Finding Value Through Credit Analysis Municipal Credit Metrics
Finding Value Through Credit Analysis GO Credit Analysis Criteria
Metric Benchmark Principal GO Debt as a percentage of No more than 2.00x the Average Debt the Issuer’s Assessed Valuation to Assessed Ratio in the residing state
Debt Limit, if applicable No less than 10% debt capacity remaining Principal GO Debt Per Capita Less than $3,500 Property Tax Collections as a % of the Levy At least a 90% collection rate
GO Debt Service relative to Property Property Tax Collections should be at Tax Collections least equal to the GO Debt Service requirements, excluding double barrel bonds The Increase in the Issuer’s debt burden as a result of Overlapping Debt No more than a 3x increase in Overlapping Debt when per capita debt exceeds $2,000
Finding Value Through Credit Analysis Revenue Credit Analysis Criteria
Metric Benchmark Essential Purpose Pledged Coverage above the applicable rate Revenues (Utility Revs) above the covenant and at least 1.25x Principal and Interest Requirements in a fiscal year.
Sales and Income Tax Pledged Coverage above the rate covenant Revenues above the Principal and and at least 1.50x Interest Requirements in a fiscal year.
Lease and/or Mortgage Lien Debt Coverage is not applicable, Structures. but lease structures may not be subject to annual appropriation without a secured interest of the facilities through a 1st Lien Mortgage
Finding Value Through Credit Analysis Additional Points of Interest
Metric Flag Change in Net Assets Declining Net Assets will be flagged to determine if the cause is attributed to operating deficits
School District’s Intergovernmental For school districts, State Sourced State Aid Dependence Funds not pledged to service bonded debt should not exceed 65% of all Governmental Funds
City and County Intergovernmental For all other governments, State State Aid Dependence Sourced Funds not pledged to service bonded debt should not exceed 45% of all Governmental Funds
Finding Value Through Credit Analysis Finding Value Through Credit Analysis Pre-Purchase Analysis
1. Hyperlinks to the Official Statement and recent financials 2. Revenue that Supports the debt service payments 3. Debt Coverage, and Rate Covenant 4. Compares the district’s debt to assessed ratio to the state’s average 5. Gross and Net GO Direct Debt (net = gross less self supporting debt) 6. Tax Assessed vs Market Value 7. Tax collections to tax levy and GO debt service 8. Any applicable GO debt limit as a percentage of the Assessed Value 9. Overlapping Debt Metrics & Per Capita 10. Dependence on State Aid 11. Change in Net Assets 12. Unemployment rates Finding Value Through Credit Analysis Post Purchase Monitoring - Credit Report
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1
2 5
3 1 Hyperlinks to the most recent financials and the bond’s official statement 6
2 County Unemployment Rate and Source of Payment (Security)
3 Type, Credit Enhancement and Ratings
4 Change in Net Assets
5 Credit Metrics: GO - Debt to Assessed, Per Capita Debt REV - Debt Coverage, Rate Covenant 6 Overlapping Debt Metrics: GO - Debt to Assessed, Per Capita Debt Finding Value Through Credit Analysis Finding Value Through Credit Analysis Municipal Credit Process
Finding Value Through Credit Analysis