A Glimpse of the Market's Future May Be Gleaned By Looking Back

Those wanting a glimpse into the future of the municipal bond market may want to take a look at the past, some market participants said at an industry conference earlier this week.

The market may reflect more what the it looked like in the mid-to-late 1980s and early 1990s than what it looked like in the intervening years, Goldman, Sachs & Co. managing director Edward Droesch said at the Securities Industry and Financial Markets Association's Municipal Bond Summit. The market is moving back to basics and putting more emphasis into credit-by-credit analysis that was marginalized to a degree as the market became somewhat commoditized by bond insurance, he said.

"The new normal is the old normal," Droesch said. The market "has gotten back to the basics of understanding credit" and looking at fundamentals, he added.

Municipal and Infrastructure Assurance Corp. vice chairman Richard Kolman said insurance penetration rates, which peaked at nearly 60%, make more sense at 25% to 30%.

Droesch praised the great diversity in the number and types of credits the municipal market offers. Regional firms will continue to play a role in helping to service all these credits, he said.

The market has also relied much more on retail buyers and mutual funds recently. Other buyers, such as tender-option bond programs and hedge funds, have played a drastically reduced role, Kolman noted.

"The clocks have been turned back," he said.

In addition, Municipal Market Advisors managing director Matt Fabian said the market may be moving back toward more "plain vanilla" financing.

And while the federal stimulus package has introduced a number of new products into the market, such as taxable Build America Bonds, it has also augmented an existing practice by increasing the buy-side participation of commercial banks.

Before the Tax Reform Act of 1986, commercial banks were the second biggest holders of municipal debt behind households. In 1985, commercial banks held $231.7 million in muni debt, or 27% of debt outstanding. In 2008, commercial banks held $215.6 million in municipal debt, or just more than 8% of debt outstanding.

But the stimulus legislation made changes to the de minimis rule and also increased the small-issuer limit to $30 million. Bank-qualified issuance has jumped 78.5% through May to 2,372 issues with a par value of $12.4 million.

Fabian said banks will focus on buying credits rated double-A or better, which will help push benchmark yield curves richer and richer.

Alan Anders, deputy director for finance in New York City's Office of Management and Budget, said once bank profitability increases, the provisions could provide an even bigger pick-up for the municipal market.

But even as the municipal market in some ways returns to the past, it will not necessarily forget the lessons it has learned in recent years.

"We're going back to the basics, but at the same time becoming much more mature in the process," Droesch said.

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER