For a while, it looked like the municipal bond market's worst nightmare. One of the country's biggest counties, which was borrowing $1.6 billion a year in the muni market, declared bankruptcy on Dec. 6 because of huge trading losses in its
investment portfolio. Even worse, now that the county's voters have voted down a sales tax increase, the county may default on $800 million in debt starting July 10.
Throughout the Orange County (Calif.) debacle, numerous experts have repeatedly predicted that the cascading series of disturbing events would severely damage the muni market: Investors would flee the market, interest rates would soar, and municipal finance would never be the same. "Just like the earthquakes in California, there will be aftershocks that are more powerful than the quake itself," says James Spiotto, a securities lawyer at Chapman & Cutler. The experts' forecasts could well prove accurate. But so far, with the exception of the county itself, the muni market has reacted with little more than a shrug.
SHORT SUPPLY. Muni investors seem unconcerned. According to AMG Data Services, an Arcata (Calif.) firm that tracks investment in mutual funds, total investment in California and national municipal bond funds--with total assets of $246 billion--has actually increased $15 billion since Orange County filed for bankruptcy. Muni funds are the major buyers of tax-free issues.
Further, the rates municipalities pay to borrow in the public market have declined. In early December, municipal bonds were yielding an average rate of 7.11%. Now, thanks in part to interest-rate declines, that's fallen to 6.27%. A drop in new municipal issues has kept munis in short supply and well priced. Contends James J. Cooner, senior vice-president and head of the tax-exempt bond management division at Bank of New York: "I just don't see any repercussions of Orange County on the wider market."
The fact that many major municipal bond issues are insured certainly has eased the anxiety of some investors. But what's more telling is that, despite Orange County, demand for bond insurance has not increased this year, and the price of insurance has been constant.
Orange County, and to a lesser extent other California issuers, have had their troubles, of course. Muni funds boycotted OC's June 27 issue--$155 million in revenue bonds backed by a letter of credit--so completely that underwriter Goldman, Sachs & Co. was forced to raise the yield on the bonds half a percentage point. Even that was not enough: Eventually Goldman bought $130 million of the issue itself. Goldman confirms the move but says it sold them at cost over the next two days.
The wrath of the funds was to be expected. Many of them are battling for repayment of OC debt they were caught holding when the county declared bankruptcy. "Orange County didn't do the right thing by its bondholders, and I wasn't going to reward them," says Stephen C. Bauer, who manages $4 billion of tax-free investments for Seattle-based Safeco Mutual Funds and was one of those sitting mut the sale. "We have a responsibility to make sure they do the right thing."
Their anger is likely to last, too. Orange County financial adviser Christopher Varelas called the boycott "a form of collusion like OPEC or the diamond cartel," but admitted OC would not return to the market anytime in the near future.
READY BUYERS. Other California issuers have been feeling the heat also. Alameda County was unable to sell an $85 million offering of revenue anticipation notes on June 27 and had to purchase a letter of credit before it could proceed with the deal. And Alameda and others have paid a premium of 10 to 25 basis points over the going market rate. MBIA Insurance Corp. of Armonk, N.Y., reports a 7% rise in the demand for insurance on long-term California bond issues as well.
But when Los Angeles County went to market earlier in June to finance a shocking $1.2 billion deficit, it found ready buyers nonetheless. "That shows you the power of the mutual funds," says Joan Payden, a Los Angeles-based bond investor.
Some experts continue to believe the future holds some fallout for the overall muni market. "Individuals are slow to react," says Jim Lynch, editor of New York-based Lynch Municipal Bond Advisory. "But what Orange County did was despicable, and people are not going to forget it." For now, though, the muni market is full of some very sunny bond issuers--even some from the Sunshine State.