Tuesday, March 1, 2011

Where Have You Gone, Meredith Whitney? Munis continue their strong rally

Defying doomsayers like Ms. Whitney, the municipal bond market continues to roar ahead.

Lack of new issue supply has helped, as well as the growing realization that not all municipal bond debt is set to default.

According to Merrill Lynch, the muni market has experienced strong rallies for the last 12 days. Over the last couple of weeks, while the yield on 10-year Treasury notes has declined by almost 24 bp to 3.42%, the 10-year AAA muni rate has declined by a whopping 42 bp to 2.97%.

Put another way, the ratio of 10 year AAA muni bond yields to comparable Treasury yields is now 87%, which is slightly below the last year's average.

At the beginning of the year munis were actually yielding more than Treasurys, which in retrospect represented a terrific buying opportunity (a fact noted by Random Glenings at the time).

My friend Nancy Marandett from Morgan Stanley brought a recent article from Bond Buyer to my attention. Titled "Bankruptcy's Bright Side: Even Under Chapter 9 Investors Get Paid", the article discusses the hold that bond holders have over most municipal borrowers.

Namely, failure to pay interest and principal in a timely fashion means that cash-strapped municipalities will be shut out of the credit markets, which is the last thing they need.

Here's an excerpt from the article, with the full link below:

With pundits predicting a "wave of bankruptcies" in the municipal market this year, experts say one thing should be kept in mind: the majority of distressed issuers undergoing the Chapter 9 process don't end up stiffing bondholders.

Dreadful images conjured up by all the talk of bankruptcy stem from what often happens in the corporate world when a company goes bankrupt. Corporate bondholders routinely take huge losses and it's not uncommon for companies to liquidate their holdings at fire-sale prices, distributing the losses far and wide.

But history suggests that municipal market dynamics compel issuers to continue paying bondholders.

Take Orange County, Calif., which infamously declared bankruptcy in 1994 after some leveraged bets on derivatives turned sour. The bankruptcy debacle — it was the nation's fourth-largest county by population — has since served as a warning that even a municipality not experiencing stagnant growth and a demographic exodus can end up in Chapter 9. But it's worth remembering how much bondholders lost during the 18-month case: not a dime.