Bulletin: Update on Municipal Bankruptcies and Multi-Notch Downgrades

The municipal market is experiencing a heightened awareness of credit risk in large measure due to high profile bankruptcies such as Jefferson County, Alabama and Harrisburg, Pennsylvania.  Pressures on municipal credits have increased over the last several years, manifesting in two notable developments: the rare municipal bankruptcy filing, and the more common multi-notch downgrade.  Samson purchases only high quality municipal securities and our strict credit criteria, grounded in our capital preservation approach, means our clients have not been exposed to any municipal bankruptcies.  Nonetheless, as these events are shaping public perceptions of broad trends in municipal credit, we thought it timely to review these bankruptcies, the increased trend towards multi-notch downgrades, and how they relate to the realities of municipal investing today.

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Bulletin: Municipal Tax Exemption and the American Jobs Act

Legislators have been discussing possible changes to the municipal tax exemption for the better part of a year now, but the President’s new American Jobs Act actually brings a formal proposal before Congress.  From a taxpaying investor’s perspective, if the proposal were to pass, the municipal market would continue to provide a high quality and uniquely tax-advantaged allocation for income generation and capital preservation, but with new pricing levels relative to taxable bonds due to the new tax rate and potential future uncertainty.

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Bulletin: Update on S&P Downgrade of U.S. Credit Rating

On August 5th, 2011 S&P downgraded the U.S. credit rating from AAA to AA+.  Moody’s had confirmed the U.S.’s Aaa rating prior to S&P’s announcement and the downgrade by S&P should not have been a surprise to the market.  Both rating agencies have retained their negative outlook for U.S. Treasuries.  Please read on for an update on the market's response and a discussion of the implications for municipals, commodities, and the dollar.

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Bulletin: Debt Ceiling Debate

With the deadline for raising the U.S. debt ceiling looming, several questions are at the forefront of our minds.  How did we get to this point?  What are the possible scenarios that could play out?  What effect will this have on the markets and on our clients’ portfolios?

Please read on as we attempt to clarify these issues.

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The Changing World of Fixed Income and Currency Safe Havens

What is a safe haven investment?  For many investors it is something that goes up in value when stock markets are roiled by surprising events.  Since news broke on March 11^th that Japan had been struck by a series of tragic events, markets have moved in ways that are both traditional - stocks down, bonds up - and unexpected - the first major G-7 currency intervention since 2000.

The human tragedy unfolding in Japan is first and foremost in all investors minds.  Yet at the same time investors are inevitably drawn to the volatility and price action in global markets, what it means to their portfolios, and to their future strategy.  The dramatic swings in market relationships since March 11^th have reinforced why certain investments, such as U.S. Treasuries, have traditionally been viewed as safe havens. The decisive role Treasuries have played in the past, however is being challenged by new competitors. Similarly, the preeminant role of the Japanese Yen and the Swiss Franc as currency safe havens may also be less clear.

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Comment on Municipal Market Media Coverage

Over the past several months, the media has been replete with articles and coverage of the municipal bond market and the financial, budgetary, and economic problems of state and local governments. Without the interest of the national media, these issues may not have gained broad attention.

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Municipal Market Bulletin

Since early November, municipal bonds have experienced a meaningful sell-off which has raised headlines in the press and caused considerable concern on the part of investors. We would like to take this opportunity to address these developments and emphasize our investment approach.

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Why the U.S. States are Not the Next Greece

The purpose of this commentary is to parse out some of the psychology facing the market by presenting data without political overtones and by dialing down the vitriolic tone. It is our contention that California and other states are not in the same precarious financial condition as Greece. Trends in US state revenues however, are weaker as economic activity continues to be lower in the aftermath of the 2008 near collapse of our financial system. Changes in resource allocation and spending choices are necessary and will continue for the foreseeable future. 

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New State of the Municipal Bond Market

Judy Wesalo Temel, Samson Principal and Director of Credit Research, has compiled a presentation that reviews recent changes in the municipal bond market regarding issuance, liquidity, credit, types of investors, and the state budgets for California and New York.  This presentation, The New State of the Municipal Bond Market, is an effective resource to assess the current economic environment’s impact on the Municipal Bond Market.  Key elements of this presentation can be downloaded here.  For the comprehensive presentation, please contact us at info@samsonca.com.

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California Bulletin

The Governor of California has declared a fiscal emergency and called a special legislative session which by law can not adjourn until the budget has been passed.  In the absence of an approved budget, the state will begin paying bills with IOUs and state Controller John Chiang has warned that the state may run out of cash entirely by the end of July.  This commentary will address certain credit fundamentals including payment of debt service, the state’s cash position, the budget and how we are positioning our clients’ portfolios.

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When Markets Disagree: TIPS, Commodities, and Inflation

If markets are efficient, can well developed and liquid markets reach opposite conclusions about the future direction and level of inflation?  If markets discount the same information about the future of inflation, yet reach different conclusions, what is the possible cause of this apparent inefficiency and how long can it last?

In the discussion that follows we will offer a thesis that seeks to reconcile the apparent contradiction in Treasury and commodity market viewpoints on inflation.  In essence, we will offer that the supply and demand characteristics of the TIPS and nominal Treasury markets are at the root of the compressed TIPS breakevens and low Treasury market inflation signals.  Additionally, we will highlight the opportunities that exist today for investors looking for ways to take advantage of the under priced inflation protection available in the TIPS market.

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Municipal Bond Market in Transition

This year saw more upheavals in the municipal bond market since the Tax Reform Act of 1986.  At this point, halfway through 2008, it is instructive to reflect on what has changed and to consider the implications for investors.  This commentary will expand upon some points that we made in the 2nd quarter commentary dated 7/11/2008.  We will focus on 5 key factors, put them in perspective and show how they will affect the market going forward.  These factors are:
• Downgrades of Bond Insurers
• New Issue Volume and Credit Structure
• Global Ratings
• State and Local Revenues
• Kentucky V. Davis

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Investment Strategy Overview: High Grade Core Intermediate

Small to medium sized foundations and not-for-profits have been under increasing pressure to generate strong investment returns to ensure they can achieve their missions.  Some of that pressure is caused by inflation in program costs, but it is also due to unusually low domestic interest rates over the past five years, and weak stock performance.  The total return of the S&P 500 over this decade through the end of March 2008, including dividends, has essentially been flat.  While the largest foundations and not-for-profits have chosen to diversify away from traditional asset classes both to enhance returns in this environment, and to better diversify their portfolios, smaller not-for-profits often do not have access to these choices.  Some have chosen not to pursue this path due to a variety of reasons including the liquidity and safety needs of the smaller foundation.  As a result, these smaller institutions have frequently emphasized fixed income to a greater extent than their larger brethren.

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Update: Municipal Auction Rate Securities Market and the Broad Market

Over the past few weeks, issuers and investors have been grappling with the volatility of the Municipal Auction Rate Securities (ARS) market.  Many issuers have had to deal with failed auctions and higher interest rates on debt that had previously provided them with an attractive cost of capital. Investors have been rewarded with higher yields while taking on liquidity risk.  Most recently, the trials and tribulations of the auction market have impacted the Variable Demand Rate Note (VRDNs) market and the municipal market in general.  In this piece, we will update you on the ARS market and give some insights on its impact on the VRDNs market and the general municipal market.

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Current Issues in the Municipal Auction Rate Market

Municipal Auction Rate Securities (ARS) have recently experienced tremendous liquidity strains.  Strong, well known municipal issuers with auction securities have seen their rates increase by hundreds of basis points even if their auctions did not fail.  These issuers are not in default, but are caught in a liquidity crisis.  ARS are estimated to comprise half of the $300+ billion total auction market and approximately 8% of the $2.5 trillion of outstanding municipal bonds.

In this commentary, specific issues relating to the current auction market are addressed.

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Assurance of Discipline

During this time of unprecedented market turmoil, we at Samson Capital Advisors would like to assure you that we have remained steadfast to our core investment discipline.  We recognize that our mandate for our clients’ anchor money is the preservation of capital, especially in times of market uncertainty.

Managing interest rate volatility risk and maintaining high credit quality are central to our core discipline.  In the low interest rate environment which has prevailed since we founded Samson, we have not seen it wise to stretch for yield by extending maturities or by lowering credit quality.  On the contrary, we have maintained our durations at the lower end of the spectrum and have maintained our credit quality focus.

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The Dollar in Historical Perspective

The financial press has remained preoccupied with the prospects for a continued decline for the dollar.  When the dollar’s condition makes it to the front page of popular magazines, as it has recently, some might argue it is time to reverse positions.  Rather than attempt to make a call on whether or not the dollar’s downtrend will continue, or whether a bull market is beginning, we would like to share with you our conclusions from a recent study we completed: “The Dollar in Historical Perspective.” 

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Kentucky Files Case with US Supreme Court on Tax Exemption of Out-of-State Municipal Bonds

The $2.3 trillion municipal bond market has developed amidst a set of long-accepted practices, beliefs and expectations.  One fundamental principle is that the interest on bonds issued by state and local governments is exempt from taxation by the federal government.  Interest on municipal bonds issued by an investor’s state has been – with some exceptions - exempt from that state’s taxation.  A corollary to this has been - again, with some exceptions - that interest on out-of-state municipal bonds is subject to taxation by the investor’s state of residence.

The premise that a state can tax the interest on an out–of-state bond has recently been challenged in Kentucky.

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What the Bank of China Can Teach Us about Investing in Foreign Currencies

The head of China’s central bank, Zhou Xiaochuan, recently announced plans to keep diversifying China’s currency reserves away from the U.S. dollar.  Zhou’s statement is important because of the power of his rationale, and because of the weight China’s large currency reserves gives to any of his statements.  He plans to reduce the central bank’s exposure to the dollar over time to enhance “safety, efficiency, and liquidity.” ^[1]

Should U.S. investors follow the lead of China’s central bank?  Furthermore, if they invested like a central bank how would this approach influence their asset allocation, their currency selection, and their non-dollar investment style?

__________________________________

Daniel Kruger, “Dollar Drops This Week as China Says It Will Diversify Reserves”, 11 November 2006, Bloomberg News.

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When Markets Disagree

If markets are efficient, can well developed and liquid markets reach opposite conclusions about the future direction of inflation?

Gold has long been viewed as a barometer of inflation expectations. In this historic context, owning gold was the original real return strategy.  For most of this period, gold and Treasury inflation expectations appear closely linked.  Then, beginning in early November, the two data series moved in different directions.  Commodity investors remained concerned about inflation, driving the price of gold higher.  Treasury investors became less concerned about inflation and Treasury market expectations for inflation fell for several weeks before rising again more recently. For the period, gold prices have risen 31%.  Treasury market expectations for inflation remain in a tight range of 2.3% to 2.6%.

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KATRINA: Long and Short Term Impact on the Bond Markets

Hurricane Katrina’s full impact on the communities it devastated, the economy, and the bond market is yet to be fully known.  But indications strongly suggest that there will be some upward pressure on interest rates, an increase in the federal budget deficit, and a major, but manageable, challenge to municipal bond insurers.

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Managing Inflation Risk for Tax Efficient Investors

Income oriented investors must be concerned not only with the absolute level of income their fixed income investments generate, but also with the degree to which their income maintains its purchasing power.  Despite recent innovations in the fixed income markets, including the introduction of Treasury Inflation Protected Securities (TIPS) in 1997, there remain few viable choices for income oriented investors concerned with tax-efficiency.  A close look at the structure of TIPS and their municipal counterparts (Municipal CPI bonds) helps to explain why there are no complete solutions for investors seeking to protect their buying power.

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FNMA: A Study in Risk and Reward

Curiously, since news of FNMA’s accounting and management problems became known, the spread of FNMA bonds to U.S. Treasuries (the extra yield FNMA pays over the yield of a comparable maturity treasury bond), has barely moved at all.  FNMA spreads remain at the richest levels in many years.  While the bond market continues to give FNMA a vote of approval, we disagree with the market’s conclusion.  As a result, we currently do not anticipate buying bonds issued by FNMA for our clients because the current yields offered by these securities do not, in our view, adequately compensate investors for the risks associated with the organization.

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