Buy side

Weekly reporting municipal bond mutual funds had a net outflow of $54 million during the period ending Nov. 28, AMG Data Services reported.

The Bond Buyer’s weekly yield indexes declined this week, as the municipal market was firmer more frequently than it was weaker in a mixed-bag week. “Muni yields in general haven’t been moving that much because there’s a lot of uncertainty in the market, as there’s no definitive positive trend to evoke trading,” said Matt Fabian, managing director at Municipal Market Advisors. “With the lack of a convincing positive price trend, secondary volume has fallen off. Price discovery has trailed off, so there’s overall less activity, and yield motion slows down.”Fabian said that this is caused in part by uncertainty over bond insurers, risk aversion due to nearing year end, and the current difficulty in hedging municipals.“It’s near impossible to fully hedge against interest rate risks in the current environment, and at the same time, we have massive interest rate risks at the long end of the muni curve,” Fabian said. “It’s hard to expect anyone to want to buy long munis right now.”He added that “the muni market right now is the ideal place if you are a total return, unhedged buyer who is looking for low returns and high risk.”Before last week’s holiday-shortened session, the municipal market was slightly firmer, following Treasuries, as investors sought quality. This week, Monday found munis were firmer by two or three basis points, though the market continued to lag behind the Treasury market, which showed sizeable gains.On Tuesday, tax-exempt yields did an about-face, declining by about one basis point across the board, following Treasuries, which experienced a correction on the heels of Monday’s sizeable gains. Munis were then weaker again Wednesday, by one or two basis points, again reflecting the movement of Treasury yields.Yesterday, however, municipals were firmer by about three basis points, as Treasuries reversed course again and showed improvement. The Bond Buyer 20-bond Index of GO yields fell six basis points this week to 4.39%, which is the lowest since 4.33% on Oct. 25.The 11-bond index dropped seven basis points to 4.32%, which is the lowest since 4.27% on Oct. 25. The revenue bond index fell three basis points to 4.77%, which is the lowest since 4.73% on Nov. 1.The 10-year Treasury note fell 14 basis points to 3.95%, which is the lowest since 3.93% on June 30, 2005.The 30-year Treasury bond fell 15 basis points to 4.35%, which is the lowest since 4.29% on Sept. 1, 2005.The Bond Buyer one-year note index fell five basis points to 3.28%, which is the lowest since 3.28% on Feb. 8, 2006.The weekly average yield to maturity on The Bond Buyer 40-bond municipal bond index finished at 4.80%, down six basis points from last week’s 4.86%.

The fallout from the credit crunch in the United States has made its way across the Atlantic Ocean and is impacting the coffers of eight small Norwegian communities, which since June may have lost up to half of their initial investment into a municipal tender-option bond trust. Hattfjelldal, which has a population of 1,562 people according to a 2004 census, invested 103 million Norwegian kroner, or roughly $18.9 million, into a Citigroup Alternative Investments off-shore focused TOB. Narvik, a community of fewer than 20,000 residents located north of the Arctic Circle, incurred enough losses through the same investment that it was planning to borrow money to pay municipal employees their December wages. Six other municipalities have come forth saying they were sold the same product and are facing similar losses. According to a Citigroup performance summary of TOB Capital Offshore obtained by The Bond Buyer, total returns in 2007 through September were negative 15.24%. August returns alone were negative 23.46%. The TOB was sold to the towns by Terra Securities ASA, an investment banking arm of Terra Gruppen. Terra Securities Wednesday filed for bankruptcy and had their license withdrawn by the Norwegian Financial Supervisory Authority, an equivalent to the Securities and Exchange Commission. “Terra Securities ASA has failed to provide information about significant risks in advance of the townships investments and has offered products to a target group that the products were not suited for,” the NFSA said in a statement when it withdrew the license. The bankruptcy voids Terra’s initial offer to repay four of the municipalities’ losses incurred after June 2007. Terra had made the repayment offer Tuesday with a statement saying it has discovered problems in the way the TOB was sold to the four towns. “Our internal investigations have discovered clear errors in the information given to the municipalities,” said Svein Erik Nordang, chief executive at Terra Securities, in a prepared statement. Terra did not return calls for comment. Payments to Hattfjelldal, Narvik, Rana, and Hemnes would have been $27.5 million plus $18 million of capital calls that were a result of losses during the period. Since June, the four towns have lost $45.5 million, which amounts to $990.16 for every man, woman, and child in each town. Total investments by the towns in the TOB have been reported as low as $96 million and up to as high as $850 million. Earlier in the week, Norwegian Finance Minister Kristin Halvorsen said at a press conference that the government would not act as safety net for municipal governments and did not plan on aiding them financially. In a statement to The Bond Buyer yesterday, Citigroup said that it “is concerned to read of the losses that investors have suffered on their investment. Losses on the investment are due to market conditions that have affected many investments around the globe, and the risks were fully disclosed to Terra Securities.” “Citi has announced that it will exercise its contractual rights to terminate the fund-linked notes that Citi sold to Terra in June 2007. Citi has the right to terminate because the market value of the transaction fell below certain trigger levels. The process of unwinding the transaction will include the mandatory early redemption of the notes and the sale of the underlying assets. The redemption proceeds of the notes will be paid to the trustee under the notes once the process for determining the final values of the assets is completed, and the trustee will then distribute them as provided in the notes.” This summer, the municipal market experienced a significant weakening and increased volatility during the first round of credit reassessment resulting from the defaults in the subprime mortgage market. Volatility peaked in August, when the yield scale for triple-A-rated general obligation bonds jumped 27 basis points from 4.51% on Aug. 13 to 4.78% on Aug. 24, according to Municipal Market Data. Earlier this week, the mayor of Hemnes provided evidence that Terra had given the municipality two prospectuses for the Citi investment, one in English and one translated into Norwegian. The Norwegian prospectus was claimed to be missing a portion of the prospectus titled “Significant Investment Consideration” that went on to detail the risk characteristics of Citi’s TOB. In a copy of the prospectus in English, the portion states “risks of the investment can include loss of all or a substantial portion of the investment due to leveraging, short selling, or other speculative investment practices.” It also notes a severe lack of liquidity for the product and that it does not expect one to develop. On this topic, Citi said that Terra Securities was advised by Citi that the product should be sold only to a similarly sophisticated counterparty. In agreements with Terra going back to 2006, the four municipalities bought into the Citi TOB with cash earned through energy sales from their hydroelectric plans. The investments would also be secured, in a contract with Terra, by the municipalities with future energy revenues. To make matters worse, the towns invested more in June this year, just as the municipal market began to falter. After the volatility of August, the communities were required to post extra capital to honor contracts made with Terra, or they would have had to lose their entire investments, according to the Norwegian newspaper Aftenposten, an English-language publication. “This is the first time that the tabloids are picking up what is normally just financial news,” said Jørn Jensen, of Jensen Asset Management LLC in Oslo. “So all of a sudden we get a human face to a complicated financial problem. Subprime impacts everyone, but this case is especially ugly after what came to light of Terra’s actions. On the bigger picture, though, this is only the beginning, and we will likely see more stories like this all over the world.” The Citigroup municipal investors TOB capital municipal portfolio is a sub-fund of Citigroup Alternative Investments. It is domiciled in Ireland. The investment strategy is that of a standard tender-option bond fund. It seeks to capture arbitrage by purchasing long-dated municipal debt, in this case between 20 and 40 years with a minimum rating of AA-minus or Aa3. It then sells short-term debt to money market funds. It is hedged on the London Interbank Offered Rate. The prospectus states that it aims to be leveraged between eight and 10 times. Eligible investments are municipal bonds, residual certificates of a TOB, or a forward-delivery municipal bond. The fund is managed by Craig Henick and Edward Sun. Jensen, who is also the former investment manager for fixed-income at KLP Asset Management, the largest life insurance and pension fund manager in Norway, said it is likely these towns did not even know the TOB was leveraged. He did express some shock, however, that the product came out of the U.S. municipal market. “It just goes to show you how far these problems reach and that no one is safe from subprime right now,” Jensen said. The prospectus is a typical one for tender option bonds, two TOB managers confirmed after reviewing the documents. The management fee is 2% per annum on capital and there is an incentive allocation. A minimum investment is $5 million. Of the other Norwegian municipalities, Rana invested the most in Citi’s TOB at $54.7 million. Four other municipalities are not part of the initial lawsuit and have yet to take action. Two of them are Helgesen, which invested $40 million, and Bremanger, which invested $31 million. The other two towns have not gone public yet, but the NFSA has confirmed that there are two more. All exchange rates used in this article are from Nov. 28.

Asset levels in municipal money market funds have reached record levels for the last eight consecutive weeks. That’s the news this week as the muni funds experienced inflows of $3.03 billion for the week ending Nov. 26.The increase in assets has accelerated after a slow start to October and puts total assets in tax-free money market funds at $456.78 billion, according to the Money Fund Report. The report monitors 550 funds.Average seven-day yields over the same period were 3.04%, up four basis points from the week before and up 11 basis points from two weeks ago. The average maturity is 31 days, an increase of one day compared to the week that ended Nov. 19. This week’s data continues the trend set during the previous week but at a slower pace. Two weeks ago, tax-free money funds had inflows of over $9 billion. Taxable funds had inflows of $31.46 billion, putting total net assets at $2.563 trillion, also a record level. The combined total is $3.031 trillion of assets under management.

The volatility of recent months will continue into 2008 but the municipal market will eventually find solid footing, said Steven Permut, senior vice president and portfolio manager at American Century Investments. Speaking at a roundtable discussion in New York yesterday, Permut said that what happened this summer and fall is a sign of a changing tax-exempt market, and one that has changed for good.“August was scary and fascinating at the same time depending on how you look at it,” Permut said. “It serves as an example of how our market has changed. We will eventually find stability but turbulence will continue through the end of 2007 and into next year.”He added: “While we will scale back volatility eventually, we now live in a new market because we have a crop of new buyers out there that change how business gets done.”Permut attributed market volatility in August to three forces, including the new nontraditional investor.“The unwinding of leverage put on by hedge funds, arbitrage funds, and tender-option bond programs; the credit default obligation exposure of insurers; and limited liquidity by the broker-dealer community are the principle reasons for the volatility,” he said.As a result, his funds have changed some of their investment strategies. He is also maintaining higher cash levels in his funds in order to be able to meet increased redemptions, should they occur.Permut said a strategy of steepening trades has paid off from American Century’s muni funds over this period.“We expect the economy to slow down and have adjusted our funds accordingly,” he said. “When this happens, you tend to see the yield curve steepen out and we look to take advantage of that.”One such steepening trade is done in the Treasury market, he noted. In this trade, the fund will buy on the short end, likely in two-year Treasury bonds, and then short on the longer end, likely in 10-year bonds. Thus, if the 10-year bond yields increase, the value of holding a short will increase. Buying on the short end will be advantageous as the bonds will appreciate as the curve steepens, assuming that short-term yields decrease.To offset the capital gains tax incurred by this transaction, the fund would enter into tax swaps.Permut said he did not expect municipal credit spreads to widen out as much as they have. He said that in his taxable debt funds, he had sold many weaker credits and bought high quality, but did not do this as much with his municipal funds. According to Municipal Market Data, the spread between triple-B and triple-A general obligation bond yields maturing in 30 years was 35 basis points on July 5. On Nov. 26, the spread was 72 basis points.Permut was quick to point to the relative cheapness of munis compared to Treasuries in today’s market, calling munis a very overlooked product. On Monday, MMD’s 30-year yields were 102.3% of 30-year Treasuries. Over the last year the ratio has averaged 87.9%. While this relative cheapness of munis to Treasuries is similar to the relationship between the assets in late August of this year, Permut said not to expect a rally similar to what occurred in September, when the market firmed on a strong retail bid.“We won’t see the rally in November because this time the problems in the market are linked to the perceived problems of the monoline insurers, and that is a big issue for retail,” he said. “This problem we have right now will take a longer time to work through the system.”American Century Investments maintains six municipal bond funds, and according to Morningstar Inc., the fund family has roughly $2.8 billion in municipal assets under management. That represents just under 3.5% of the company’s total assets.

A $1 billion California general obligation offering leads the way in the primary new-issue market this week, as investors will digest $6.1 billion of bonds when a week of full sessions begins today following the Thanksgiving holiday. The estimate is higher than both the $5 billion of bonds and notes that came to market last week, which was dominated by a $3.8 billion North Texas Tollway Authority note sale, and also exceeds the $5.1 billion that was priced the week before. “The big deal [this] week is obviously the California deal. That’s going to dominate,” said Evan Rourke, portfolio manager at MD Sass. “Demand overall has been moderate. Individual investors have not been terribly active, and I think that’s probably due to the absolute level of yields.” “In the Treasury market, we have the 10-year note poised to break through a 4% [it went as low as 3.978% Wednesday and was quoted near the end of the session at 4.01%], and while munis are offering good relative value to Treasuries, the absolute level of yields is just keeping individuals out of it,” he added. “With institutionals, there’s a good bid for high grades, but away from that, I’d say the demand is soft.” Tom Spalding, senior portfolio manager at Nuveen Investments, said that the California deal will be a “bellwether issue” that should illuminate “what the true demand is out there.” “Demand is going to be not quite the flight to quality that we have seen in Treasuries, but it’s going to be an alternative investment for certainly retail, and property and casualty companies continue to have money, so I think the real buyers will be back in,” Spalding said. “The other part of the equation is that dealers don’t want to stock bonds at this stage of the calendar, this late in the year.” In the week’s largest scheduled transaction, UBS Securities LLC will price $1 billion of various-purpose GOs for California Thursday. The credit is rated A1 by Moody’s Investors Service and A-plus by Standard & Poor’s and Fitch Ratings. However, this follows Standard & Poor’s revising its outlook on the state’s credit rating to stable from positive Tuesday. The agency cited downturns in projected tax receipts and the state’s track record of failing to take corrective mid-year action when budget numbers prove soft. The bonds will be used to finance environmental protection projects, parks projects, construction of school and university facilities, housing projects, and children’s hospital projects. Orrick, Herrington & Sutcliffe LLP and Gibbs & Oliphant LLP are co-bond counsel. Public Resources Advisory Group is financial adviser. Tom Dresslar, spokesman for state Treasurer Bill Lockyer, said that no one can predict how the market will respond to the bonds this week, but that the state will “make sure our underwriters get the best possible price for taxpayers.” “We switched from competitive to negotiated to take advantage of the retail demand in the current market,” he said. Dresslar also said that the state will make a decision on the extent to which it insures any of the bonds on the pricing date. Just last week, Clark County, Nev., School District, rated AA by both Standard & Poor’s and Fitch, came to market with a $650 million GO sale, which it brought uninsured, in keeping with a growing trend over the past few weeks, where investors are looking more at underlying ratings. “General generic insured bonds are definitely lagging, so you’re really seeing a much more widened spread between the top credits and the lower credits,” Rourke said. “There’s a much more nuanced approach to credit here than we’ve had in years, where people are not just looking at the insurer, they’re looking at the underlying rating.” Rourke said the Clark County district deal is one that in the past would typically have come with insurance. “Normally for issues like this, the issuer would put insurance on the bonds, because it didn’t cost much, and they felt the value of the triple-A credit was worth it,” he said. “This week, that deal came and there was the sentiment that, 'Don’t put the insurance on it, it doesn’t matter.’ And the market is definitely in flux because of that, because everyone is trying to determine what that right spread is. I think the market is still trying to make that transition.” California last came to market with $2.5 billion of various-purpose GOs last month, priced by Goldman, Sachs & Co. in two series. Bonds from the larger, $1.5 billion new-money series, came to market mostly uninsured. Those bonds mature from 2008 through 2010 and from 2022 through 2027, with term bonds in 2032 and 2037. Yields range from 3.34% with a 3.3% coupon in 2009 to 4.75% with a 5% coupon in 2037. Bonds maturing in 2022 are insured by XL Capital Assurance Inc., and bonds maturing in 2023 are insured by Financial Guaranty Insurance Co., while all other bonds are uninsured. Also, bonds maturing in 2008 were not formally re-offered. Bonds from the $1 billion refunding series, however, featured a steady diet of insured paper. Bonds mature from 2009 through 2025, with yields ranging from 3.34% with a 3.3% coupon in 2009 to 4.52% with a 4.5% coupon in 2025. Portions of bonds maturing from 2014 through 2023 are insured by Assured Guaranty, Ambac Assurance Corp., FGIC, XL Capital, and MBIA Insurance Corp. All remaining bonds are uninsured, and bonds maturing in 2008 were not formally re-offered. Among uninsured 5% coupon paper in the deal, bonds maturing in 2012 were tightest to that day’s Municipal Market Data triple-A yield curve, with yields 21 basis points over the curve. Bonds maturing in 2032 and 2037 were widest to the scale, with yields 41 basis points over. Among insured 5% coupon paper in the deal, Assured Guaranty-insured bonds maturing in 2014 were tightest to that day’s MMD triple-A yield curve, with yields 17 basis points over the curve. MBIA-insured bonds maturing in 2020 and 2021 were widest to the scale, with yields 23 basis points over. The spread has since tightened by between four and 12 basis points among uninsured 5% coupon bonds, and by six basis points among insured 5% coupon paper in the $1.5 billion new money deal, according to Tuesday’s MMD triple-A yield curve. However, spreads in the $1 billion refunding have mostly widened, ranging from narrowing by two basis points to widening by 15 basis points among uninsured 5% coupon paper, and between narrowing by two basis points and widening by nine basis points among insured 5% coupon bonds. In other activity, the Los Angeles Unified School District will competitively sell $600 million of tax and revenue anticipation notes, which mature in December 2008. The notes are rated MIG-1 by Moody’s. Merrill Lynch & Co. will price $450 million of sales tax bonds this week for Washington’s Central Puget Regional Transit Authority. The underlying credit on the bonds, which will be insured by Financial Security Assurance Inc., is rated Aa3 by Moody’s.