Sub-Prime Crash Hits Municipal Bonds

September 21, 2007
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BIRMINGHAM — The reported credit crunch that emerged from what some have called the subprime mortgage fiasco has already had an effect on the municipal bond market.

Buyers are seeking higher yields due to the uncertainty surrounding the financial markets. A higher yield could come from a bigger interest rate, a deeper sales discount, or both. The crunch’s timing could have a negative impact for future local bond sellers like Kent County, which has plans to finance at least two construction projects through bonds in the coming months.

“It’s having an effect now. Absolutely,” said Tom Enright, managing director of the Birmingham office of Oppenheimer & Co. Inc.

Enright said the current buyer buzzword in the municipal market — whether the securities are bonds, notes or T-bills — is liquidity. He said the current market is the most illiquid one that underwriters have seen in recent history. Those in the securities world define liquidity as being freely able to buy and sell securities in an open marketplace.

“The problem is, the market is frozen up. The buyers don’t know whether to buy at the rate they’re seeing. The sellers don’t know whether to sell at the prices they’re seeing, because no one quite knows which way the credit crunch — the big monster out there — is going to go,” he said.

Not knowing is the definition of uncertainty and, as Enright emphasized, the market hates uncertainty more than anything else — even more than a war, a terrorist attack or a natural disaster.

“Uncertainty sends the market into a tailspin. Right now there is a mood of uncertainty,” he said. “People want more return for their investment. They factor in the uncertainty, and there is a cost for that. They want a higher return for their investment right now.”

That demand, of course, either raises the cost of debt for a sale or lowers the proceeds from a sale or does both for a seller.

Still, Enright said the current market condition doesn’t mean that transactions aren’t being completed, as his office recently closed a refinancing deal. But what the current state does mean is that sellers are selling in a market wanting interest rates that are higher than they would be if the subprime problem hadn’t surfaced.

“If you factor in those higher rates and are prepared to accept that, and if your numbers work at those higher constraints, then you sell your bonds and you go forward,” he said.

“But a lot of people are holding back and waiting to see how it’s going to stabilize.”

How much higher do those rates have to go? That’s uncertain, too. Enright said the rate depends on how secure the seller’s credit is, and one number can’t fit all situations because situations change and may do so unexpectedly. A case in point is six months ago. No one expected a crash in the subprime mortgage market, and that means no interest rate is truly permanent in any market including the municipal market.

The Birmingham office of Oppenheimer & Co. has handled almost every bond Kent County has issued in recent years, and the firm may be selected to underwrite a few more within the next few months. The county plans to upgrade its Fuller Avenue Campus, build a new 63rd District courthouse, and construct a new building for the Department of Human Services within the next year.

The county’s current thought is to sell two bond packages: one for improvements to the campus and for the courthouse, and another for the DHS building. Earlier this year, the ratings services renewed the county’s Triple A bond rating. Kent is one of only 42 counties in the nation with that financial status, and Enright said that rating is critical to the county, even with a big monster lurking in the market.

“The one thing that everybody has to keep in mind is that it’s the same market that goes on any other day. It’s the same thing interacting; everything is just operating on a higher level,” he said.

“The rating is just as important. Kent County’s Triple A rating isn’t going to give them some extra special interest rate, given the market. They’re going to get the rate they deserve, given the market, and right now it’s going to be higher.”   

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