Public Finance Update - January 2009

In 2008, municipalities issued $390.6 billion in bonds – approximately 9% less than in 2007. Volume fell most dramatically in the last quarter, declining more than 50% in October and almost 26% in December. Moreover, refundings were up for the year by nearly 43%, indicating that new issues suffered significantly more than the overall 9% drop suggests. In fact, just over 7,400 new issues were sold in 2008, which is the lowest number since 1993.

By year’s end, the largest issuers with the highest quality credit were able to access the bond markets, but only to a limited extent. Frozen credit, asset deflation, declining tax revenues, and unemployment are likely to continue, constraining municipal finance volume for the rest of the year. Some market observers still hope for recovery during the second half of 2009. For example, in November 2008, the California Department of Water Resources ("DWR") sought to convert $523 million of its variable rate bonds to a fixed rate. But the pre-Thanksgiving market would only accept conversion on $173 million, forcing $350 million of the variable rate debt back to liquidity providers. DWR’s failure to convert its entire issue further stifled the California bond market, leading smaller issuers to postpone or cancel pending deals. Last week, however, DWR successfully restructured and sold the remaining $350 million of bonds, garnering yields between 4.47% and 4.88%.

The U.S. Senate Finance Committee is expected to vote on certain portions of the pending economic recovery bill in January 2009, and Congressional Democrats have expressed hope that the entire bill may be approved by early February. The bill is expected to include over $300 billion in tax cuts and close to $500 billion in stimulus spending. The stimulus dollars are expected to target infrastructure projects in most of the 50 states, including upgrades to roads, schools, and utility systems. Although early drafts of the bill do not include provisions specifically related to municipal bonds, it is hoped that an infusion of new infrastructure dollars will spur new bond activity and accelerate the recovery of the bond market. Congressman Barney Frank (D-MA) has introduced legislation that, among other things, would provide authority for the purchase or guarantee of municipal debt by the federal government. The National Association of Bond Lawyers has submitted a white paper to Congress outlining recommendations for incorporating tax-exempt debt into the stimulus legislation.

The California budget crisis is alive and well. In December, Governor Schwarzenegger called a special session of the State Legislature to address the impasse in the California budget. State Legislators proposed several budgetary alternatives, including a Democratic proposal that would reclassify certain taxes as fees, thereby eliminating the requirement for a two-thirds vote. The Governor vetoed the fee concept, and California Republicans are holding firm to their commitment against any new taxes. The California Department of Finance has estimated that the State will face a combined $41.6 billion budgetary shortfall for fiscal years 2008-09 and 2009-10. State Controller John Chiang authored a letter to State agencies requesting the issuance of IOUs to certain payees beginning February 1, 2009, to preserve cash for debt service and educational payments.

The table below highlights certain economic indicators that help provide insight into the municipal bond market. The spread between taxable obligations and tax-exempt bonds are at historical lows, making municipal bonds relatively cheap. The information in the table is as of January 15, 2009, unless otherwise noted.

Gross Domestic Product (3Q versus 2Q, 2008):	–0.5%
Consumer Price Index (11/08 versus 10/08):	–1.7%
Existing Home Sales (11/08 versus 10/08):	–8.6%
New Home Sales (10/08 versus 09/08):	–5.3%
Housing Starts (10/08 versus 09/08):	–4.5%
Yield on 10-Year Treasury Notes:	2.18%
Yield on 30-Year Treasury Bonds:	2.86%
Yield on 10-Year Municipal Bonds:	3.54%
Yield on 30-Year Municipal Bonds:	4.80%

 

Sources:
Gross Domestic Product: U.S. Bureau of Economic Analysis (www.economicindicators.gov)
Consumer Price Index: U.S. Bureau of Labor Statistics (www.bls.gov)
Existing Home Sales, New Homes Sales, and Housing Starts: National Association of Realtors (www.realtor.org)
Bond and Note Yields: Bloomberg (www.bloomberg.com)