The once-boring municipal bond market is getting lots of play since
Meredith Whitney's market-moving prediction that U.S. cities would
default on their bonds.
Since then, there's been debate over how much trouble the muni
market is actually in. Advisor Intellgence contributor Shah Gilani
wrote about the likelihood of muni-bond defaults saying banks were
less likely to issue letters of credit that many bond issuers rely on.
But Forbes writer Robert Lenzner argues that defaults will be rare.
This morning's Wall Street Journal reports that state and local
governments are incredibly slow to disclose their finances to
investors. Investors are angry about the lack of transparency and the
SEC wants to make sure municipalities are disclosing vital information
to bond holders, the article says.
But Alan Zafran, a partner with financial advisory firm Luminous
Capital, told me this morning that municipalities are infamous for
filing financial statements in an untimely matter, and the matter is
nothing new.
That doesn't make the situation any better, especially for retail
investors who he says might be not as aware of that fact, but he
argues that the matter may just be another overblown muni bond story.
_Below is Zafran's take on the matter:_
The WSJ article is a classic example of "old news" being trumpeted
into a sector in technical distress, in this case, municipal bonds.
With headlines like this and more to follow, the selling pressure in
this space will not go away any time soon.
I am NOT trying to downplay the significance of this article's
importance. In fact, untimely and incomplete disclosure of financials
is an appalling fact for many smaller, non-investment grade
municipalities.
However, it is a well-known fact among investment professionals, if
not the public, that many municipalities (particularly smaller and
non-investment grade issuers) have been consistently delinquent in
filing financial statements. But in a time of distress such as now,
the warts begin to rise to the surface.
Here are 5 takeaways for investors in the municipal bond market:
* The article implies that there $1.0 trillion of municipal bonds
available for purchase with timely and complete financial
disclosures, which is safe to assume are the bonds from larger,
investment grade issuers. Be forewarned that sticking to high
credit quality municipal bonds has never been more paramount to an
investor.
* This is an inefficient, relatively illiquid market. Look at the
damage that $20 billion in redemptions in recent weeks (less than
1% of total market) has caused to municipal bond prices.
* Imagine what might happen to this market if retail investors
continue to sell their bonds into this illiquid market. Headlines
like this are not going away any time soon, as the lagged impact
of the 2008-2009 recession will be evidenced in the budget cuts
and fiscal strains now being faced head-on by municipalities whose
fiscal years end on June 30th. Deep cuts, accounting gimmicks,
and tax increases (guised as fees or levies) will all be part of
the formulae used by municipalities as a means to find a way to
balance the next fiscal year's budget.
* What if I told you that there will be 10 times as many municipal
bankruptcies in 2011 than in 2010? Scary, huh? Well, there were
only 6 municipal bankruptcies in 2010 (5 of the 6 were of very
small dollar amounts), so the shock value of this figure (bear in
mind that there are something like 55,000 issuers and 91,000
outstanding bond issues) may well lead to further, uninformed
selling on the part of retail investors, creating yet-further
selling pressure on the market.
* Risk/Volatility can also translate into Opportunity. As "the
baby is thrown out in the bath water" and municipal bonds are
indiscriminately sold, there will be ample opportunity for astute,
fundamentally-oriented investors to "pick off" creditworthy
bonds at incredibly attractive tax-free yields in a world where
ordinary income tax rates are inevitably headed higher. Be
patient, pick your spots, and position yourself to acquire
attractive tax-free income for many years to come.
_Alan Zafran has served as a financial adviser to wealthy families and
institutional investors for the past 20 years. He began his career at
Goldman Sachs in 1990 in the Private Client Group. After seven years
at Goldman Sachs, Alan and his entire team joined Merrill Lynch in
1997. At Merrill Lynch, Alan helped to build the Private Banking and
Investment Group. In May 2008, Alan and his partners launched
Luminous Capital._
Source: Forbes.com
