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Debt Fight Sparking Muni Fears

JUL 19, 2011 7:18pm ET
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The failure of lawmakers in Washington to come to grips with a fast-approaching deadline to boost the federal debt ceiling is beginning to affect the municipal bond market.

Some of the nation’s ­strongest muni credits are reevaluating when to bring their bonds to market as Moody’s Investors Service on Tuesday placed five of the 15 triple-A rated states on review for possible downgrade.

Moody’s said the five states were targeted due to their fiscally sensitive relationship with the U.S. sovereign credit. Moody’s on July 13 warned that the Unite States could lose its Aaa rating if there is a default due to failure to raise the debt ceiling by Aug. 2.

About $24 billion of rated municipal debt is impacted by Tuesday’s action which ­affects Maryland, New Mexico, South Carolina, Tennessee, and ­Virginia.

“Should the U.S. government’s rating be downgraded to Aa1 or lower, these five states’ ratings would likely be downgraded as well,” Moody’s  said.

Analyst Nicholas Samuels said the risk factors are macroeconomic sensitivity, capital markets reliance, and dependence on federal revenues, which are offset by financial resources available to counteract those risks.

Maryland, which had its triple-A rating affirmed by Moody’s on July 14, was put on the list for the high concentration of federal government workers and contractors in its tax base.

The impact on Maryland is more immediate: it has a $100 million general obligation retail order period scheduled for Friday, plus a competitive deal for $390 million and a $206 million debt refunding, both scheduled for next Wednesday.

“In terms of the broader situation, nothing has changed between last week and this week,” said Maryland Treasurer Nancy Kopp, referring to the Moody’s action.

Maryland does not borrow for cash-flow purposes, and Kopp said the new-money deal — 50% of which is going to Maryland public schools — could be postponed with no detrimental effects save that projects could be delayed.

“Those are public schools that might not be built because of this totally unsettled situation in Washington,” Kopp said Tuesday.

“If things look steady for us and for our taxpayers then we will go forward with the deal,” she added. “If the folks in Washington cast such a pall upon things that people become very nervous and decide they don’t want to invest, then we’ll hold back.”

Traders said there appeared to be little or no impact on prices following the announcement from Moody’s.

The Aaa ratings and outlooks of 10 other states, considered more resilient by Moody’s, were left unchanged. They are Alaska, Delaware, Georgia, Indiana, Iowa, Missouri, North Carolina, Texas, Utah and Vermont.

Triple-A rated Montgomery County, Md., is unaffected by the agency’s move, but chief administrative officer Timothy Firestine said the debt ceiling debate is making him nervous.

“Absolutely, it is weighing heavily on our thoughts,” Firestine said Monday.

Montgomery is scheduled to auction $259.4 million of GO refunding bonds and $320 million of public improvement bonds in a competitive bid on Aug. 3, one day after the statutory debt-limit deadline.

Firestine said the county’s advisers are considering moving up the deal’s sale date, especially if there’s any indication the triple-A rating is in jeopardy.

The inaction in Washington already has resulted in the suspension in sales of state and local government series securities. SLGS sales were halted by the Treasury in mid-May to conserve capacity under the debt limit.

Municipal issuers buy SLGS and place them in escrow accounts to pay debt service on advance refunded bonds and avoid arbitrage limits in the tax code.

The Treasury normally offers SLGS with maturity dates that match those of the muni bonds being refunded.

With the SLGS window closed, finding securities to escrow has now become a greater challenge.

“The debt ceiling discussion and the fact that the SLGS window is closed is certainly complicating the mechanics of our refunding that we’re looking at next week,” said Eric Sandler, director of finance at the San Diego Water Authority.

The closure means the authority will have to bid in the open market versus just buying SGLS for its escrow account. Sandler estimates the additional cost at $15,000 to $20,000.

The SLGS closure “is really very annoying,” especially for issuers with small and short escrows, according to David Cholst, a partner at Chapman & Cutler. “It is very difficult to do bidding of open market securities when the amounts are very short or very small.”

Cholst said some issuers are facing negative returns on the short-term Treasuries they need.

“That’s where people have been having problems,” he added. “People really want this to be solved.”

With this week’s issuance estimated between $8 billion and $10 billion — by far the biggest week in 2011 — some issuers may be issuing more now to lock in low rates and avoid what might be a volatile period in early August.

The biggest deal expected this week is from Washington State, which is taking bids on $742 million of GO bonds in three separate issues. The bonds are rated AA-plus.

Chris McGann, spokesman for Treasurer James McIntire, said the political debates in the nation’s capital haven’t played a role in the state’s current borrowing plans. The state posted its preliminary official statement on July 8 and the sale has been “queued up for quite some time.”

“We don’t like the froth in Washington, D.C., but we don’t see it impacting our immediate plans,” said McGann, adding that the market’s stability has been encouraging.

Washington took orders on a portion of the  bonds Friday and Monday in its first retail order period in more than 14 years, according to McGann.

He said appetite was “very good” and exceeded expectations. So far, the debt ceiling debate has had no discernible impact on Treasury or municipal rates.

The 10-year Treasury closed Tuesday at 2.88%, versus 2.95% one month ago; Municipal Market Data’s 10-year muni ended Tuesday at 2.66%, versus 2.63% one month ago.

A spokesman for Tennessee’s comptroller remained confident investors would discriminate between federal politics and his state’s healthy balance sheet.

“If a downgrade occurs as a result of a lowering of the federal rating,” he said, “you can make no mistake Tennessee will meet its obligations.”

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