Tuesday, October 13, 2009

Bond (Debt) Disease Spreads to Washington State…

Under pressure and after witnessing California botch their latest auction, Washington State proactively reduces their bond offering knowing that higher rates are here.

The spin masters are all talking that higher interest rates are good, they are a “sign of recovery.” What they are not discussing is the MASSIVE amount of debt that needs to be rolled over and that debt levels have risen to the point that any increase in rates severely impacts the budgets of those debt holders who is nearly everyone. Muni bonds are a high risk proposition in this environment, rates WILL rise, it’s just a matter of when.

States falling short by billions of dollars is a symptom of the credit bubble and subsequent collapse. Those who believe that debt can continue to grow at the present rate are simply living in a fantasy world. Governments at all levels are way overextended, they grew as the credit bubble grew and now they must shrink but they are too slow to react. The economy will force them to shrink…

Washington Slashes Muni Offering With Investors ‘Overstretched’

By Jeremy R. Cooke and Michael McDonald

Oct. 13 (Bloomberg) -- Washington state will cut the size of its tax-exempt bond offering by 36 percent after borrowing costs rose from a 42-year low.

The state that is home to Microsoft Corp. will shrink a planned $875.7 million offering tomorrow to $563.9 million, said Chris McGann, a spokesman for the treasurer’s office in Olympia. Washington is rated AA+ by Standard & Poor’s, Aa1 by Moody’s Investors Service and AA by Fitch Ratings.

State and local government bonds extended their declines today, pushing higher benchmark yields tracked in a daily survey by Municipal Market Advisors of Concord, Massachusetts. Yields on 10-year debt rose 6 basis points, the most since June 10, to 3.16 percent. A basis point is 0.01 percentage point.

Morgan Stanley Smith Barney said dealers are becoming less willing to take on inventory that may undermine a profitable year. Issuers plan to sell about $8.5 billion of fixed-rate bonds, down from the eight-week high of $11 billion last week, based on data compiled by Bloomberg.

Washington originally planned to sell $1.38 billion of general obligation securities this week. In addition to the tax- exempt debt tomorrow, Goldman Sachs Group Inc. and JPMorgan Chase & Co. are to market $500 million in taxable Build America Bonds Oct. 15, according to data compiled by Bloomberg. The issues will fund capital improvements and refinance debt.

Rebounding yields may reduce the savings states including Hawaii and Mississippi get from refinancing taxpayer-supported debt. Investors balked at low payouts while anticipating a Federal Reserve rate increase. The Bond Buyer 20 index of 20- year general obligation securities climbed to a three-week high of 4.06 percent after reaching 3.79 percent, the lowest since 1967, on Oct. 1.

“It’s pretty obvious, interest rates are not going to stay at zero in any kind of economic recovery,” said Joseph Deane, who oversees the $4.9 billion Legg Mason Western Asset Managed Municipals Fund at Western Asset Management in New York. The fund’s five-year average return of 5.7 percent is best among its peers, according to Bloomberg data.

Fed Fund Futures

Trading in federal funds rate futures today implied a 57 percent chance the U.S. central bank will raise its target for overnight lending between banks by April 2010. The Fed’s target has been for a range of 0 to 0.25 percent since December, easing the way for credit markets to rally.

“The first time the Fed finally tightens, I think that’s the best news you’re going to get in a long time,” Deane said in a telephone interview. “They’re telling you the economic crisis is abating.”

The Municipal Master Index from Bank of America Corp.’s Merrill Lynch & Co. is up 14.9 percent for 2009, better than any other year-to-date period since the total-return gauge began in 1989. The index fell 1.2 percent last week.

The municipal market “got overstretched,” Deane said. “Everybody was just grabbing every bond they could get.”

The gains were driven by investors pouring a record $65.5 billion into municipal bond mutual funds, according to data cited in an Oct. 9 report by George Friedlander, municipal strategist at Morgan Stanley Smith Barney in New York, a joint venture of Citigroup Inc. and Morgan Stanley. The previous full- year record was $42.9 billion in 1993.

‘Don’t Mess It Up’

“The mantra now seems to be ‘don’t mess it up,’ so some dealers and traders appear to be paring back their bid side significantly,” he said.

Bondholders sought offers for almost $2 billion in securities Oct. 7, the highest since late June, according to a bids-wanted index compiled from Bloomberg data.

California, the lowest-rated and most-populous U.S. state, reduced its bond deal last week by 8 percent to $4.14 billion and raised tax-exempt yields as much as 60 basis points, or 0.6 percentage point, from initial discussions. Delaware, one of seven states with the highest credit ratings, decreased the size of its refinancing by 9 percent to $314 million.

“We were able to get a $4 billion-plus deal in a cold and inhospitable market,” said Tom Dresslar, a spokesman in the California state treasurer’s office. “We believe that is a significant accomplishment.”

Extra Yield

The extra yield investors get for buying municipal bonds rated BBB instead of AAA widened by about three basis points last week to 228 basis points, after tightening from 446 basis points at the end of 2008, according to Merrill index data.

The falling yield premiums led Deane to reduce investments in riskier bonds “the past month, month and a half,” he said.

“We’ve been diminishing our risk profile somewhat because we felt that this has been a terrific run, we’ve hit it on the screws and we’re willing to take a few chips off the table,” Deane said.

Friedlander in his weekly report recommended against reaching for yield on general obligation bonds by “going down too much in credit quality.”

“Budgetary pressures at the state and local level are likely to continue for at least two years, and this should lead to more downgrades, even if defaults are limited as we expect,” he said. “Consider revenue bonds.”

The largest municipal bond insurers by new issues this year sustained credit-rating cuts yesterday. Fitch Ratings reduced its financial strength grade on Assured Guaranty Corp. to the fourth-highest grade of AA- from AA. Assured’s Financial Security Assurance Inc. unit was downgraded to AA from AA+.

Municipal issuers have scheduled at least $15.9 billion in fixed-rate bond sales during the next 30 days, 35 percent more than this year’s $11.8 billion average, according to a visible- supply index compiled from Bloomberg data.