Municipal Bond Deals Squeezed By Credit Crisis
Thursday, November 29, 2007
The widening credit crunch is making it harder for cities and school systems to get money for buildings, ballparks and other vital projects from the $2.5 trillion market for municipal bonds, a sector of Wall Street that rarely sees trouble.
That is leaving them with a tough choice: either put off the projects, or pay higher interest rates on their bonds, a cost that ultimately would fall on the backs of taxpayers.
The problem is affecting municipalities with lower credit ratings, which require them to pay more to borrow money.
Faced with the prospect of paying higher interest rates this month, Chicago canceled a $960 million bond. Miami-Dade County pulled a $540 million offering for its airport. And the District has a $350 million bond for schools, parks and roads scheduled for next month that could be delayed if credit conditions continue to deteriorate, a top D.C. finance official said.
Several finance directors said it is unusual for turbulence to hit municipal bonds, a tax-exempt investment that has long been considered safe.
"There's some unique and maybe even unprecedented dynamics that have been occurring because of the credit crunch," said Lasana Mack, the District's treasurer.
For the past several years, cities and towns have been able to borrow money by issuing bonds that pay historically low interest rates. That era of easy money is ending for many municipalities, mostly because of spiraling losses in the mortgage industry that have been driving up borrowing costs.
The municipal bond market has been squeezed by steep losses among bond insurance firms. Towns and cities with poorer credit ratings often rely on these insurers to back their bonds, enabling them to pay lower interest rates. But now bond insurers are facing massive write-downs because they promised to cover losses in the mortgage industry, leading some to stop insuring new projects.
"It's opening a lot of eyes that not only the big banks were getting overextended in these mortgage markets segments. Bond insurers were right there with them," said Robert Nelson, managing analyst at Thomson Financial.
Some bond insurers are running out of money. A few are in danger of having their credit downgraded, which could cripple their business. The stock prices of most of the companies, including MBIA and Ambac Financial, have plummeted in recent weeks.
Without insurers helping them, lower-rated municipalities face even higher interest rates. It's a double whammy for them because in addition to higher borrowing costs, many municipalities are experiencing declines in tax revenue as real estate values fall.
The turmoil is emblematic of how the credit mess is spreading across Wall Street in unpredictable ways. If it continues to roil municipal bond markets for a sustained time, it could pull airport users, city residents and even sports fans into the pain. Many towns and cities are already facing higher borrowing costs; further problems in the bond market could cause hospitals to put off constructing new wings and make some transportation projects more expensive to finance.
Maryland and Virginia have the highest credit rating possible, "AAA," and have been largely unaffected by the bond market's problems.
The District, which is rated "A," typically relies on insurers to issue bonds. It would likely have to pay a higher interest rate when it issues its $350 million in general obligation bonds in December, debt market analysts said. That money would pay for renovations at Brightwood Elementary School, Hardy Middle School and Cardozo High School; rebuilding of the 11th Street and Sousa bridges; and improvements to the Woodrow Wilson High School indoor swimming pool, and Roper/Deanwood Recreation Center.
The $355 million bond the District issued last year for the new Washington Nationals stadium dropped in value this month on the secondary markets, where municipal bonds, after they are issued, are traded on exchanges like stocks. That drop was a sign that investors are shunning debt instruments they consider risky.
The District escaped the market pain on its stadium bonds because it locked in a low interest rate when they were originally issued. The recent performance of those bonds is a bad sign, though, for other cities that want to finance stadiums through the debt markets.
Some municipalities are putting off bonds altogether. Miami-Dade County had planned a massive bond, backed by airport revenue, that would have financed capital improvements to Miami-Dade airport. The project was given an A-minus rating, which is at the low end of investment grade bonds. The county sought the help of a AAA-rated bond insurer. But the interest rate still wound up being much higher than the county wanted to pay.
"Unfortunately, when we went to market, the market was very volatile and we were not able to achieve the savings that we needed," said Rachel E. Baum, finance director for Miami-Dade County. "That's one of the reasons why we pulled it. We were disappointed. . . . It is unusual."
The municipal bond market problems have not yet reached a critical stage, said Stanley Milesky, Baltimore's chief of treasury management. Compared with the 1990s, interest rates are still at a low level.
And the municipal market for all of 2007 will likely break records for total volume of long-term bonds issued, largely because the municipal bond market was roaring for the first nine months of the year; the slump started in late October. Through the end of September, states and municipal issuers sold $324 billion in bonds this year, up 22 percent over the same period last year, the Securities Industry and Financial Markets Association said.
The trouble, Milesky said, is occurring more at the fringes of the bond market, but "it could catch people unaware."
Other municipal finance directors and analysts said they are increasingly concerned that the credit mess will lead to a broader slowdown.
"When access to credit is being restricted to a municipality that borrows money, there are trickle-down effects throughout the economy," said Nelson, the Thomson Financial analyst. "It's tough to tell how this will work itself out. I don't think anybody has a really good answer. For many it's a wait-and-see mindset."