MIAMI - Although the federal government has taken steps to aid the municipal market, it must do more to help issuers facing the "greatest fiscal crisis since 1933," including possibly providing direct credit enhancement on muni bonds, Rep. Gerald Connolly, D-Va., said yesterday.
Without federal support, state and local governments will be forced to make cuts that counteract the effects of the federal stimulus bill for the entire country, Connolly told market participants gathered here for The Bond Buyer and Regional Bond Dealers Association National Municipal Bond Summit.
In addition to direct guarantees, the federal government could also consider supporting a mutually owned bond insurer or repackaging municipal bonds into some sort of Treasury securities.
"The best approach is one that restores confidence," Connolly said.
The congressman expects the next piece of legislation to help municipal issuers will be months rather than weeks away, but said the Treasury probably already has authority to take some actions that could help the muni market.
He encouraged market participants to e-mail him at Connolly.muni@mail.house.gov to provide their thoughts on these issues so that all ideas can be considered.
The recently passed stimulus package provided some potential to boost demand for municipal bonds through modifications to the de minimus rule for financial institutions and increasing the small-issuer exception to $30 million from $10 million on bank-deductible bonds.
But the market still suffers from liquidity issues due to such problems as the lack of credit enhancement capacity and the loss of many of the buyers that helped support the new issuance that reached historic highs in recent years, such as tender-option bond programs and hedge funds.
Although the market has improved for the highest quality, most liquid credits in recent weeks, it's still difficult for lower rated issues to get to the market. Spreads remain wide, with a Baa-rated, 30-year general obligation bond yielding 228 basis points over a Aaa-rated, 30-year GO, according to Muncipal Market Data.
"Clearly, we still have a liquidity problem, especially on the lower end of the market," Steve Heaney, head of public finance at Stone & Youngberg LLC, said while moderating a panel yesterday.
The lack of credit enhancement has also left a hole in the short-term, variable-rate market. The difficulties of finding liquidity facilities have prevented issuers from accessing the short-term market, even as yields trade at historic lows. In addition, investors in the short-term market are beginning to reach their concentration capacity limits for the liquidity providers that are available.
Many issuers last year turned to letters of credit as they moved to variable-rate demand obligations after the collapse of the auction-rate securities market. But "trying to find LOCs in today's market at reasonable prices is extraordinarily difficult," Bob Inzer, county clerk of Leon County, Fla., said during a panel.
Even for issuers that already have letters of credit, a potential shock awaits them as those LOCs come up for renewal this year.
"Now letters of credit are coming back for renewal and that's a pretty big problem," said Everspan Financial Guaranty Corp.'s Robert Shoback. "The federal government must recognize that."
Market participants suggested the federal government could help ease liquidity problems in a number of ways. It could provide direct guarantees, it could ask the Federal Reserve to open up its commercial paper purchasing program to tax-exempt debt, or it could help fund an insurer.
Inzer headed a blue-ribbon panel convened by the National League of Cities that recommended exploring the concept of a national, mutually owned insurer. Unlike a private company, the insurer could focus on minimizing risk and the cost of accessing the capital markets for issuers, rather than focusing on profits.
The entity would need to be capitalized more than bond insurers typically have been, Inzer said. Federal capital is needed to move forward, but the company would also raise capital from pension funds and other sources, such as debt service reserve funds set aside by individual issuers.
Talk of such an entity is still in its early stages, but Inzer said proponents have yet to find any "deal killers" in their discussions with rating agencies, investors, brokers, and other market participants. The company would be professionally managed and take steps to prevent politics from influencing its underwriting decisions.
"I've heard it said that the best people to solve problems are the people that have the problem," Inzer said.
Beyond new entrants to the market, such as the Municipal and Infrastructure Assurance Corp. and existing bond insurers MBIA Insurance Corp. and Ambac Assurance Corp., plan to capitalize muni-only insurers to try and re-enter the market.
Ambac, which has plans to recapitalize Everspan, the old Connie Lee Insurance Co., has been lobbying in Washington, trying to get federal support through a capital injection, excess loss guarantee, or other means, Shoback said.
"We need something to stabilize ratings and restore confidence," he said.
MBIA this week unveiled plans to capitalize a new muni-only insurer through its MBIA Insurance Corp. of Illinois.
