Download Municipal Bonds: Finding Value Through Credit Analysis

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 nontraditional
municipalities (e.g.
American Airlines BK,
Tobacco Corps)
Finding Value Through Credit Analysis
Municipal Defaults Are Rare
Defaults 07-11 By Type
Special
Assessment
16%
Other
5%
G.O.
1%
Revenue
78%
Finding Value Through Credit Analysis
Defaults 2007-11 By Tax Status
BQ
2%
NBQ
84%
Taxable
5%
AMT
9%
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%
4yrs
9%
1yr
15%
3yrs
6%
2yrs
8%
In 2009, 72% of all financials were
more than 2 year old
% of Issues 3+ Years Delinquent by ST
90.00%
80.00%
Average filing time is 228
days after fiscal year-end
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
Source: DPC DATA Inc., “Recent Trends in Municipal Continuing
Disclosure Activities”, February 3rd, 2011
Finding Value Through Credit Analysis
0.00%
WY VT ME MT
ID
SD
UT
NE
AK
IA
OK DE
VA ND
LA MS AZ
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
PrePurchase
Analysis
Purchase
Decision
Defaults mostly coming from smaller issuers
Finding Value Through Credit Analysis
PostPurchase
Analysis
Justify
Position
Defaults mostly coming from non-rated (NR) securities
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
concentration of municipal
bonds relative to their
capital, they better dazzle
me with credit analysis”
…FDIC Capital Markets Examiner
Municipals / Tier 1 Capital
Q4 2011
Q3 2011
Q2 2011
Q1 2011
Q4 2010
Q3 2010
Q2 2010
Q1 2010
Q4 2009
Q3 2009
Q2 2009
 Buying a municipal bond
Q1 2009
should be viewed in the
same manner as making
a loan. Pre- and postpurchase credit analysis
is just as important.
Q3 2008
Finding Value Through Credit Analysis
Q4 2008
Q2 2008
Q1 2008
Q4 2007
Q3 2007
Q2 2007
Q1 2007
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
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
 Principal GO Debt as a percentage of
the Issuer’s Assessed Valuation
Benchmark
 No more than 2.00x the Average Debt
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
 GO Debt Service relative to Property
Tax Collections
 At least a 90% collection rate
 Property Tax Collections should be at
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
 Essential Purpose Pledged
Revenues (Utility Revs) above the
Principal and Interest
Requirements in a fiscal year.
Benchmark
 Coverage above the applicable rate
covenant and at least 1.25x
 Sales and Income Tax Pledged
Revenues above the Principal and
Interest Requirements in a fiscal
year.
 Coverage above the rate covenant
and at least 1.50x
 Lease and/or Mortgage Lien
Structures.
 Debt Coverage is not applicable,
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
 Change in Net Assets
Flag
 Declining Net Assets will be flagged to
determine if the cause is attributed to
operating deficits
 School District’s Intergovernmental
State Aid Dependence
 For school districts, State Sourced
Funds not pledged to service bonded
debt should not exceed 65% of all
Governmental Funds
 City and County Intergovernmental
State Aid Dependence
 For all other governments, State
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
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
and recent financials
Revenue that Supports the debt
service payments
Debt Coverage, and Rate Covenant
Compares the district’s debt to
assessed ratio to the state’s average
Gross and Net GO Direct Debt (net =
gross less self supporting debt)
Tax Assessed vs Market Value
Tax collections to tax levy and GO
debt service
Any applicable GO debt limit as a
percentage of the Assessed Value
Overlapping Debt Metrics & Per
Capita
Dependence on State Aid
Change in Net Assets
Unemployment rates
Finding Value Through Credit Analysis
Post Purchase Monitoring - Credit Report
4
1
2
1
3
Hyperlinks to the most recent financials and the bond’s official statement
2
County Unemployment Rate and Source of Payment (Security)
3
Type, Credit Enhancement and Ratings
4
Change in Net Assets
5
Credit Metrics:
6
Overlapping Debt Metrics:
GO - Debt to Assessed, Per Capita Debt
GO - Debt to Assessed, Per Capita Debt
REV - Debt Coverage, Rate Covenant
Finding Value Through Credit Analysis
5
6
Finding Value Through Credit Analysis
Municipal Credit Process
Finding Value Through Credit Analysis