For all the talk of credit issues driving the municipal bond market this year, only a minority of participants actually cite it as a top determinant.
According to a recent survey conducted by RBC Capital Markets, 29% of state and local government experts cited low issuance as the factor driving the muni market this year.
Headline risk, the jargon for negative media coverage, received 24% of the votes. Credit quality, much hyped this year as a key shaker of yields, received top billing by just 16% of respondents.
The survey of 116 experts was conducted at The Bond Buyer’s Sept. 14-16 California Public Finance Conference.
“The biggest risk to the muni market today is interest rates, not credit,” John Dillon, chief muni strategist at Morgan Stanley Smith Barney, wrote in a Oct. 7 research note. He called it ironic that in spite of rising default-related anxieties the past year, municipals continue to trade in the shadow of Treasuries.
According to a three-month rolling average maintained by Municipal Market Data, 10-year and 30-year triple-A munis have traded at a correlation of more than 0.90 to comparable Treasuries since mid-August. A perfect correlation would be 1.
Almost two-thirds of survey respondents, 64%, expect the same amount or fewer state and local government defaults in 2011 versus the previous year. In February, the figure was a similar 63%, but just 11% believed there would be fewer defaults then, while now 35% do.
Distressed Debt Securities suggests $1.18 billion of municipal bonds had defaulted through late September, versus $3.61 billion in the previous 12 months.
“There has been a recent positive shift in the way people view the state of the municipal industry,” said Chris Hamel, head of public finance at RBC. “The potential for a slowing economy results in uncertainty surrounding state budget and fiscal issues, but current market conditions are better than they were nine months ago.”
However, the time horizon for state and local government revenues returning to pre-crisis levels had drifted further out. Just 8% of respondents said two years or less, whereas back in February it was 27%. Nearly half, 44%, thought it would take five or more years, versus just 23% in February.
When asked about state and local finances in California — recently dubbed a “nightmare scenario” by Vanity Fair writer Michael Lewis — 53% called pension funding the biggest challenge. Education expenses received 19% of the vote, and infrastructure gathered 16% support.
Nationally, 39% of respondents said infrastructure such as roads, bridges and airports was the biggest funding challenge, while 34% cited pensions and 19% pointed to health and human services. Shorter hurdles include education expenses, transportation and environmental issues.
And surprise: 92% of respondents opposed President Obama’s proposal to cap the tax-exemption on munis at 28%.
