Municipal Market Update
December 4, 2008
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Discussion Topics
Recent events in the capital markets
Impact on national and local municipal markets
Historical interest rates
Continued challenges with Bond insurers Commercial banks Investment banks
Summary
Contact information
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Timeline of Capital Markets Developments
Skyrocketing housing prices lured real-estate speculators
This created even more demand and drove the cycle further
US economy is healthy; interest rates are low and consumers feel confident
This helped push up real-estate values
With values escalating, lenders felt more confident about making mortgages to customers whose poor credit histories had prevented them from buying homes in the past
2000
Note: This timeline is highly simplified for discussion purposes
Sources: Ponder Investment Company research and NPR.org news articles
2006 2007
The mortgage market began seeing an increase in defaults and delinquency to a level that exceeded modeled expectations
Property values stopped increasing or started to decrease
Adjustable Rate Mortgages (ARM) began to reset higher
2008
Defaults in the mortgage market began to spill over into the asset-backed security and CDO markets and seeped into every area of the financial markets
There is great concern about the exposure of major investment banks, and several banks were downgraded
The rating agencies are concerned about the exposure of bond insurance companies, and a full review is initiated
Uncertainty and volatile markets continue as investors seek liquidity and safe credit structure
Volatility expected to continue
Recession expected to last until 2010
Sub-prime loans expanded to 20 percent of the mortgage market in 2006, from 9 percent a decade earlier
Home ownership reaches a record high of 69% in 2004
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A Historic Quarter for Wall Street
Week of Significant Events
September 15 • Lehman files for bankruptcy; Bank of America announces buyout of Merrill Lynch• AIG downgraded; government “Invests” $85 billion• Reserve Primary Fund “breaks the buck”
Treasury and Fed bolster Money Market Funds (“MMF”) with a guaranty program; extended to municipal market late in the week• Investor fears spurs flight to quality
Investors pull nearly $80 billion from money market funds The 3-month Treasury yield falls to near zero
• Global central banks join to unfreeze credit markets; U.S. Treasury announces $700 billion bailout plan• Goldman Sachs and Morgan Stanley, the only two remaining investment banks, become bank holding companies
September 22 • Morgan Stanley announces sale of up to $8.5 billion in stock to Japanese bank Mitsubishi• Warren Buffett’s Berkshire Hathaway announces a $5 billion investment in Goldman Sachs• FBI begins investigating Fannie Mae, Freddie Mac, Lehman Brothers and AIG for potential mortgage fraud• Washington Mutual is closed by the US government in the largest failure by far of a U.S. bank; the assets are sold to
JPMorgan Chase for $1.9 billion• EU government steps in with several major bailouts
September 29 • Citigroup agrees to acquire Wachovia’s banking operations for $2.1 billion in stock; later in the week, Wells Fargo offers $15.6 billion
• The House rejects the proposed bailout plan; the Senate approves the revised plan by a 74-25 vote; the House approved the revised plan by a vote of 263-171
• Commercial banks, investment banks and AIG borrowed a record $410 billion from the Federal Reserve
October 6 • Passage of the bail-out plan doesn’t allay market fears; the Dow drops below 9,000 for the first time since 2003• Fed announced a plan to buy commercial paper in an effort to thaw short-term lending markets• The Fed and several other foreign central banks lowered interest rates in an unprecedented coordinated effort• AIG to receive an additional $37.8 billion loan from the Fed• Treasury announces plans to buy stakes in a wide range of banks
October 13 • Volatile stock market continues• Report that housing starts fell to second lowest rate in 50 years• Hedge funds saw a record $210 billion drop in assets under management during the third quarter
Source: Various news reports; Citigroup market update presentation dated 10/23/08
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Week of Significant Events
October 20 • U.S. Government and N.Y. Attorney General open joint investigation into the $34.8 trillion credit-default swap market• Municipal bonds rally most in 26 years as the tax-exempt market thaws; yields drop 73 basis points in one week (nearly ¾ of
1%)• AMBAC and MBIA make bid for government help under rescue plan• Federal Reserve announces plans to shore up money market mutual funds
October 27 • Commodities head for their worst month since 1956 on concerns that a slump in global economic growth will sap demand for raw materials
• Commerce Department says gross domestic product contracted in the third quarter at the fastest annual pace since 2001
November 3 • U.S. Treasury announces its plans to sell $55 billion in long-term government debt this quarter as a slowing economy balloons the budget deficit to a record level
• U.S. Treasury announced major changes to its auction schedule, reflecting what is likely to be a record high $1 trillion-plus budget deficit this year
• JPMorgan Chase, UBS and Royal Bank of Scotland, three of the world’s biggest banks, say they expect further pain from the global financial crisis
• Financing arm of General Motors, GMAC, posted its 5th straight quarterly loss and said its mortgage unit may not survive
November 10 • Treasury Secretary Paulson announces plan to use the second half of the $700 billion financial rescue program to help relieve pressure on consumer credit, scrapping an effort to buy devalued mortgage assets
• General Motors stock drops 30% after an analyst cuts price target to zero• American Express gets Fed’s OK to become a bank holding company
November 17 • Mortgage write downs and rising audit costs could push Freddie Mac’s 2009 losses into the range of $20-$40 billion, according to an analyst
• China takes over Japan’s spot as the biggest foreign holder of Treasury bills, notes and bonds• Standard & Poor’s drops AMBAC from AA to A• Fears about deflation push Dow Jones to close below 8,000 for the first time since March 2003
A Historic Quarter for Wall Street (continued)
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Impact on the Municipal Market
The immediate impact on the municipal market was high interest rates and a halt to new bond issues coming to market
Flight to quality generally meant investment in U.S. Treasuries which has pushed benchmark treasury yields to 50-year lows with the 2-yr at 1.00% and the 10-yr at 2.93% as of 11/28/08
Massive out-flows from municipal money market funds resulted in significantly higher rates SIFMA Index (1) resets
Few new variable-rate demand bonds were issued Many commercial banks have been unwilling to provide LOC support for new issues during
this volatile time Investment banks have been reluctant to take on additional remarketing business when it
was so difficult to successfully remarket debt currently outstandingDaily Variable Rate Demand Bonds (“VRDBs”) have significantly out-performed weekly bondsNo new fixed-rate bond issues came to market for several weeks
1) The Securities Industry Financial Market Association Index is a 7-day index comprised of tax-exempt variable rate demand bonds (“VRDBs). The Index represents a cross section of national VRDB issues. The rate resets on every Wednesday afternoon and becomes effective on Thursday.
9/10 1.79% 10/22 2.28%9/17 5.15% 10/29 1.82%9/24 7.96% 11/5 1.26%10/1 5.74% 11/12 1.14%10/8 4.82% 11/19 1.12%
10/15 3.45% 11/26 1.03%
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Short-term Variable Rates
Although the relationship between SIFMA and 67% 1M LIBOR has held over the long-term, the current credit turmoil has caused a spike in short-term tax-exempt VRDO yields in late September.
The SIFMA index as of 11/19/08 was 1.12%, implying a short term ratio of SIFMA to 1M LIBOR of 79%. The disruption in the tax-exempt market is attributable to several factors:
– Seasonal tax implications (September 15 tax payments and September 30 quarter end)– Money Market Fund Assets down substantially in late September– Flight to quality given credit and economic environment– Failed remarketings that result in higher rates– Widening demand gap between troubled and well-regarded Letter of Credit banks
Over the past month the market has responded positively– MMFs have begun to experience net inflows– Strong investor demand for new “untainted” VRDO issues
Significant concerns remain regarding concentration of exposure to relatively few bank names and uncertainty surrounding practical impact of central bank guarantees
(1) Based on market conditions as of November 21, 2008 and subject to change. SIFMA = 1.12% and 1M LIBOR = 1.39%
(2) Fixed spread quoted based on a Act/360 day count basis.
On September 24th, SIFMA
reset at 7.96%
0.0
2.0
4.0
6.0
8.0
67% of 1M LIBOR SIFMA Index
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Impact on the Municipal Market
Tax-exempt market has begun to recover
MMFs beginning to see net inflows; strong demand for short-term paper easing variable rate borrowing costs
Merrill Lynch brought a fixed-rate healthcare deal to market on October 23, the first in over six weeks
Providence Health and Services (Aa2/AA)
Yield of 6.70% in 2038 which reflects a credit spread of 1.33% versus 0.50% one year ago
In October and November strong AA and A rated credits begin coming to market, including Trinity (St. Alphonsus) and St. Luke’s
Credit spreads remain in the +1.50% to 1.80% for strong credits
The first BBB+ transaction went to market in October
Loma Linda, CA, with credit spread of 2.89%
Forward looking supply is still substantial
Transactions that can access retail distribution are benefiting with lower interest rates
Conditions still very volatile from day to day
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2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
Apr-07 J ul-07 Oct-07 J an-08 Apr-08 J ul-08 Oct-08
"A" Healthcare Revenue Bond SIFMA Swap
67% LIBOR Swap AAA MMD
Recent Trend in Long-term Fixed Rates
Graph shows the relationship between indices over the past 18 months
Key Stats (1) 30 YR “A” Healthcare (2) 30 Yr SIFMA Swap (3) 30 Yr 67% LIBOR Swap (3)
As of 11/21/2008 7.15% 3.53% 2.22%
Average 5.44% 3.94% 3.41%
Min 4.51% 3.33% 2.12%
Max 7.44% 4.47% 4.09%
Std Dev 0.67% 0.22% 0.31%
(1) Rate history provided from April 2007 through November 21, 2008(2) Approximate “A” rated Healthcare traditional fixed rates. Rates are estimates and do not necessarily reflect actual traded levels.(3) Swap rates are quoted at mid-market and do not include any ongoing costs
Trinity Pricing Summary
Highlights of the market includedStrong retail demand in IdahoOne of first 5 Healthcare transactions to come to market in six weeks due to credit crunchSignificant institutional investor participation
The limited supply of Idaho municipal bonds was a plus with institutional investors
Idaho benefit of 12 to 30 basis points
Issue: MI Hosp Finance Auth- Trinity Health Credit Group Issue: IDHealth Fac Auth- Trinity Health Credit Group
Aa2/AA Aa2/AA(Moody’s/S&P) (Moody’s/S&P)
Pricing 10/28/2008 Pricing 10/28/2008Par $192.795 million Par $178.31 millionPar call 12/1/2018 Par call 12/1/2018Maturity Amount Coupon Yield Spread
to AAAMaturity Amount Coupon Yield Spread
to AAA12/1/2014 5,905 5.00% 5.25% 1.58% 12/1/2014 5,110 4.75% 4.95% 1.28%12/1/2015 6,205 5.25% 5.40% 1.57% 12/1/2015 4,040 5.00% 5.11% 1.28%12/1/2016 6,535 6.00% 5.60% 1.60% 12/1/2016 4,610 5.25% 5.29% 1.29%12/1/2017 6,895 5.75% 5.00% 1.58% 12/1/2017 4,505 5.40% 5.45% 1.28%12/1/2018 7,290 6.00% 5.90% 1.55% 12/1/2018 7,155 5.63% 5.65% 1.30%12/1/2019 5,000 6.25% 6.05% 1.54% 12/1/2019 4,550 5.63% 5.80% 1.29%12/1/2023 34,515 6.12% 6.25% 1.40% 12/1/2023 41,260 6.00% 6.10% 1.25%12/1/2028 22,825 6.25% 6.50% 1.46% 12/1/2028 45,415 6.13% 6.35% 1.31%12/1/2034 97,625 6.50% 6.65% 1.40% 12/1/2034 61,665 6.25% 6.50% 1.28%
192,795 178,310
Bond Ratings
Bond Ratings
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Challenges for Healthcare Providers Accessing Capital Markets
Investment Banking Firms 3 top underwriters exited the municipal business
Bear Stearns
UBS
Lehman
Others, including Citigroup, under pressure and reluctant to commit capital
Reduced headcount through mandatory reductions in force
Significant decrease in available capital
Product offerings have changed dramatically, and differ by firm
Increased return on capital requirements, putting further pressure on fees
Monoline Bond Insurance Companies No consensus on long-term stability of any insurer
Little perceived value of bond insurance
Higher premiums and more restrictive covenants
Requests for consent difficult and costly to secure
Credit Enhancement Providers (primarily commercial banks) Letters and lines of credit significantly more costly
Covenants more restrictive
Trading levels increased due to market capacity constraints
Provision of credit tied to additional fee business
Regional banks gaining business
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Bond Insurer Ratings November 24, 2008
Moody’s S&P Fitch
ACA Not Rated A to CCC Negative Dev
12/19/2007
Not Rated
AMBAC Baa1 Developing Outlook
11/5/2008
A Negative Outlook
11/19/2008
Rating Withdrawn
6/26/2008
Assured Guaranty Aa2 Stable
Downgrade from Aaa on 11/21/2008
AAA Stable
6/18/2008
AAA Affirmed Stable
12/12/2007
BHAC Aaa Stable AAA Stable Not Rated
CIFG B3 Under Review
10/28/2008
B Watch Developing
8/22/2008
Withdrawn
10/21/2008
FGIC B1 Negative Outlook
6/23/2008
CCC Negative Watch
7/31/2008
CCC Negative Outlook
7/31/2008
FSA Aa3 Developing Outlook
Downgrade from Aaa on 11/21/2008
AAA Negative Watch
10/9/2008
AAA Negative Watch
10/10/2008
MBIA Baa1 Developing Outlook
11/7/2008
AA Negative Outlook
8/14/2008
Rating Withdrawn
6/26/2008
Radian A3 Negative Outlook
6/25/2008
BBB+ Negative Outlook
8/26/2008
Rating Withdrawn
5/2/2008
XLCA (Note is now Syncora)
Caa1 Under Review
10/24/2008
B Watch Developing
11/18/2008
Rating Withdrawn
9/05/2008
Sources: Moody’s Investors Service; Standard & Poor’s; The Bond Buyer; UBS; Morgan Stanley; WSJ Online
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Current Underwriting Experience
Variable Rate Debt
For direct pay letters of credit deals, rates have returned to one to two percent and lower in some instances
For standby letters of credit, insured transactions, and issues with other credit concerns, variable rates are as high as 7%
Fixed Rate Debt
Access to market remains very volatile even for highly rated issuers and has become more difficult in the last two weeks
Longer underwriting periods for negotiated transactions and shorter notices for competitive transactions are becoming more common
Underwriters are less willing to commit capital by taking down bonds without increased underwriting spreads
Difficult to find buyers throughout the entire maturity structure
Mitigation Measures
Be flexible with timing and structure
Smaller issues are better because of strong but limited retail demand
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Idaho Tax-Exempt Market
Idaho Market for fixed rate, tax-exempt debt has performed relatively well:
Low supply of bonds; likely to continue
Retail demand is strong
Conditions are still very volatile; similar transactions receive wildly varying reception only days apart
What could change on a local basis
If rates fall significantly, retail is less likely to be a major factor. Six percent appears to be threshold level
If rates decline, issuance could rise as slated refundings reach market
Issuance is likely to remain relatively low because decrease in housing development will mean fewer school bonds
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Summary
The relationship between SIFMA and 1-month LIBOR has normalized, at least for now
Current VRDB programs should trade at or near SIFMA with the following qualifications
VRDBs with “tainted” credit support may continue to trade off significantly
– Involvement of bond insurers
– Credit quality of the supporting bank
– Expertise of the remarketing agent
Daily VRDBs may continue to out-perform weekly VRDBs in the near term (months?)
– Daily liquidity more valuable to investors than weekly liquidity
– Many remarketing agents will not agree to take on the risks of daily remarketing
New bond issues are limited by access and cost of credit enhancement
Self-liquidity is a good option for strong (AA) borrowers
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Summary, continued
The fixed-rate market appears to be opening up, particularly for highly rated credits, but there remains significant supply of new bonds with limited investor demand
The Bond Buyer’s 30-day visible supply as of December 2, 2008 was $21.3 billion, highest since October 2002 and 55% higher than the 12-month average
In recent years, institutional demand has been driven by tender option bond programs (“TOBs”) and leveraged buyers who have been under pressure from dislocated muni/Treasury ratios and margin calls
Many investors set up TOBs when the 30-year muni/Treasury ratio was 90% while recent levels were 134%, resulting in losses
Major broker-dealers have been imposing margin calls on customer TOBs
As VRDBs are put back to dealers, some are losing financing and therefore being forced to liquidate assets
High short-term rates may cause TOB programs to unwind if the short-term funding cost exceeds the coupon on the bonds
Retail investors have become much more important than in the past, but institutional buyers are still a major requirement for successful sale of a large issue
Covenant and security packages are more restrictive now than in the past
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Summary, continued
Developments that could improve the municipal debt market include the following
Fear needs to subside and confidence needs to be restored
Continued retail buyer interest is important for sale of fixed-rate bonds and to support municipal money market funds
New issue volume and/or secondary market portfolio unwinding needs to ease and be absorbed
Crossover buyers need to return to the market, lured by relative upside and cheapness of municipals
Broker-dealers need to re-commit capital to improve liquidity in the marketplace
Financial products have generally performed as expected
With the possible exception of auction bonds, where investors significantly under-priced the value of liquidity
Market uncertainty increases cost, security requirements and investor scrutiny
“Flight to quality” behavior by investors tends to disproportionately affect the tax-exempt market
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Contact Information
Michael Lewis, Vice President Public Finance Office phone: 208-344-8587 Mobile phone: 206-330-7656 Email: [email protected]
Michael Tym, Vice President Office phone: 219-531-2369 Mobile phone: 312-961-0274 Email: [email protected]
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