Muni Market Spurns Early Sellers in 2011, Franklin’s Costas Says
Municipal bonds withstood calls for widespread defaults in 2011 to return more than 10 percent, proving to investors that markets are unpredictable, said Rafael Costas, co-director of municipals at San Mateo, California-based Franklin Advisers, which manages $72.4 billion of the debt.
Costas discussed what lies ahead for the muni market in 2012, including the rise of direct bank loans and lack of bond insurance, for today’s issue of the Bloomberg Brief: Municipal Market newsletter.
Q: What was the biggest storyline for the municipal market in 2011?
A: How far off those predictions that got the most press actually were. Unfortunately, a lot of investors were misled into selling at the worst possible time. Who knows what they put their money into? After all was said and done, one year later, the municipal market would have been one of the best places in which to have put your money.
You just don’t know what’s going to happen. It’s a good reminder to investors that no matter how smart you think you are, or how well you have it all thought out, it pays to diversify because you could be wrong.
Q: What will be the biggest storyline for the municipal market in 2012?
A: The market will be watching how the Jefferson County (3681MF) bankruptcy proceedings go, to see what’s challenged and what stands up to challenges.
Of course we have an election year, so there will be a lot of talk and a lot of posturing about how we have to get a better handle on our country’s financial house.
You’ve seen some proposals where people are talking about how municipal-bond interest is going to be treated and about whether it’s going to remain completely tax-exempt. It could be something, it could be just political posturing.
Q: You say it’s inaccurate to classify dipping into reserve funds as defaults. Why?
A: A default to us and to most people is you don’t get paid when you’re supposed to be. It is useful to know when issuers are dipping into reserves because it is a warning sign, but that’s what reserves are for! They’re here for the tough times and to give you a cushion so you don’t have a default.
To claim that dipping into reserves is a default is almost irresponsible. You’re painting a picture that’s worse than it should be, and it doesn’t allow for how much you dipped into reserves.
If all you’re dipping into reserves is 5 or 6 percent, you have a good 15 years before you actually start thinking about missing a payment.
Q: Do you see bond insurance making a comeback in the municipal market?
A: It’s going to be a while, but the original premise of bond insurance will be valid. Bond insurance was originally a tool for small issuers that are not as widely known. So when they came to market, the insurance they could get made them that much more marketable and liquid.
As we work out of the effects of the financial crisis, you’ll see more than 5 to 7 percent of the market being insured, but I don’t know where it’s going to end up. It’s certainly not going to be 50 percent of the market anytime soon.
Q: Are you concerned at all about the amount of private placements and direct bank loans in the municipal market?
A: One of the concerns we have is it’s hard to document. I don’t mind municipalities taking advantage of every way they can to raise capital in the way that’s most advantageous to them, but it should be disclosed.
You have public debt out there, and that’s public information. And I certainly as a bondholder of any entity would like to see in the financial reports at the end of the year if they did issue some other debt on the private side.
I don’t object to it -- I just need to know because it impacts my analysis when we’re looking at a bond. As long as it’s being disclosed, I don’t have a big concern with that new market. They need to access capital in the best way that they can for their taxpayers and their citizens. As a bondholder, I just want to make sure they’re disclosing their debt, and they’re not diluting the security of existing bondholders.
Q: What effect, if any, does the European debt crisis have on the municipal-bond market?
A: The European situation unfortunately is affecting every market around the world. You see the headlines -- stocks go up or down by 200 or 300 points based on European fears. It does have an effect, mostly on Treasuries.
I don’t think many Europeans are coming in to buy municipal debt. Whenever the situation in Europe clears up and people feel more confident in investing in other assets for the long haul, I would expect some selloff in Treasuries. And I’d expect munis to perform better when that day comes.
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