As one the largest bankruptcy financings to date prepares for pricing this week, amid an estimated $7.9 billion in new volume, municipal experts are divided in their opinion over the outcome of the deal, the investor base that will and should ultimately buy the bonds, and the terminology used to describe its ratings.
The $1.8 billion Jefferson County, Ala., sewer warrant deal raised eyebrows on Friday when it thundered into the market for the first day of its retail order period where yields on some of the subordinated debt were offered at close to 8%.
Even the senior-lien current interest warrants that are insured by Assured Guaranty Municipal Corp. were offered with a 5.50% coupon at par in 2044 during the order period at the same time that the benchmark, triple-A general obligation scale in 2043 closed unchanged at a 4.13%, according to Municipal Market Data.
The insured senior bonds are rated A2 by Moody’s Investors Service, and AA-minus by Standard & Poor’s and have underlying ratings of BBB from Standard & Poor’s and BB-plus from Fitch Ratings.
“I think you’re going to start to see some people take that step into the market strictly because of that yield opportunity,” said Tim Barbera, managing director of sales, trading and underwriting at Rice Financial.
During the retail pricing on Friday, for instance, the scale offered convertible capital appreciation bonds from one of the uninsured subordinate series at a 7.75% yield in 2050, subject to a 2023 conversion.
The subordinate bonds are rated BBB-minus from Standard & Poor’s and BB by Fitch.
“It’s a retail opportunity — even though the credit has the proverbial stigma, people are saying let’s take a chance here,” given the broader picture of a weak economy and stock market volatility, Barbera explained.
“It’s hard to find spread in this market, so that’s one of the things the county has going for it,” a veteran municipal analyst declared.
“We already have somewhat of a two-tiered market where there are narrow spreads on high-quality paper and the outliers are paying big prices to get their deals done, and in this case, I think the latter is going to be true,” the analyst explained.
“I think they are going to get some pretty decent retail reception, especially on the Assured Guaranty bonds,” according to Barbera.
“The insured bonds should have demand at the yields being discussed,” a source at a large New York City firm said. “The uninsured will require hedge fund involvement.”
But at least one municipal analyst was skeptical about the presence of retail demand and on Friday lashed out at Standard & Poor’s analyst James Breeding, who in a webcast on Thursday said the deal’s triple-B ratings should be considered “borderline non-investment grade.”
“I think there is a substantive problem with rating agency personnel believing that a BBB-minus rating is merely a notch different from a BB-plus rating,” said Dick Larkin, senior vice president and director of credit analysis at H.J. Sims & Co.
“The difference between investment grade and non-investment grade within the investing world is more than a notch — it is a chasm,” he told The Bond Buyer on Friday.
“Moody’s and Fitch were correct to rate below investment grade, given this issuer’s willingness to pay,” he added.
Larkin continued to say that he was surprised that the deal was given bond insurance “in light of the traditional dependence on insuring only investment-grade debt.”
He said he would also be “surprised” if retail investors participate in the deal judging by the county’s track record and the speculative nature of the planned financing. It has been in financial crisis since its $3.2 billion of variable- and auction-rate sewer warrants, and related swaps, collapsed in early 2008 during the market crash and subsequent decline of bond insurer ratings. The county has been in bankruptcy since November 2011.
Larkin said he also has a new stance on hedge fund involvement in the municipal market, saying: “There is demand for hedge-fund bond purchases from discredited borrowers like Detroit and Jefferson County.”
“Frankly, traditional municipal bond investors should treat these issuers as pariahs, making them ideal candidates for lenders that need not conform to the traditions of cautions in lending, which has been the hallmark of the municipal bond market, and the biggest reason why municipal bond defaults remain rare — despite the meltdowns by Detroit and Jefferson County,” Larkin continued.
“Hedge funds are more likely to be participating in this deal because they are already looking for high yields and they are willing to take the chance” that the county will recover from bankruptcy, the veteran analyst agreed. He said a large chunk of municipal bond mutual fund might be absent from the deal given the rough year they have experienced.
"Mutual fund outflows are still taking place and there are fewer funds that need to add bonds to their portfolios," the veteran analyst said. "If they are going to be buying it, it's because the additional yield is sufficient enough to make them really selective."
Besides the Jefferson County deal, this week a $1.5 billion Port Authority of New York and New Jersey offering of consolidated bonds for transportation improvements will be priced by Wells Fargo Securities amid the $7.90 billion estimated by Ipreo LLC and The Bond Buyer.
The new volume compares to the revised $4.86 billion that came to market last week, according to Thomson Reuters.
While size is about the only thing the mammoth deals have in common, issuers hope to attract captive buyers nonetheless when the deals are priced within days of each other.
Analysts say the plain-vanilla, high-quality Port Authority deal with its ratings of Aa3 from Moody’s Investors Service, and AA-minus from Standard & Poor’s and Fitch Ratings will come in stark contrast to the Jefferson County deal.
The Port Authority will price its deal Thursday, following Wednesday’s retail order period, with a three-pronged structure that includes bonds subject to the alternative minimum tax, non-AMT bonds, and a taxable tail.
While conservative, high-quality, retail and institutional investors will likely prefer the Port Authority deal, back in Alabama there will be some retail and institutional investors willing to put the risks aside to satisfy their hunger for high returns, municipal players said.
“I think you will see a lot of high-yield funds in there, and some funds where they can fit it in and are allowed to, will get in there just for the sheer yield,” Barbera said, adding that the yields would rival that of those on Puerto Rico bonds in the secondary market trading at 400 basis points off the benchmark scale.
“Besides Puerto Rico there isn’t much out there,” Barbera said. “It will be very interesting to see how the market receives these.” Nonetheless, he said, traders won’t be able to ignore the elephant in the room.
“I think you have to follow it as a trader, as an underwriter, as whatever role to you play at your firm just so you can understand where things are going here,” Barbera said.
In other large deals, the Los Angeles Department of Water and Power will issue $380 million of water and sewer revenue bonds on Thursday, following a retail-order period on Wednesday led by Wells Fargo. The bonds, which are rated Aa2 by Moody’s and AA by S&P and Fitch, is structured to mature serially from 2017 to 2035.
In addition, Chicago will sell $326 million of second-lien revenue refunding bonds on behalf of Chicago Midway Airport on Thursday in a three-pronged deal that includes tax-exempt AMT and non-AMT bonds, as well as taxable bonds, and is rated A3 by Moody’s and A-minus by Standard & Poor’s and Fitch.
