Muni Meltdown: All Eyes on California

As the world focuses on Ireland, the hammering of the U.S. muni market continued today even as the treasury bond market rallied sharply.  As the case with any sell-off, it is difficult to discern fundamentally why the market is in complete meltdown.  A big supply of Build America Bonds has hit the market before the federal subsidy expires at the end of the year, swamping demand.   The Muni ETFs (see chart) now trade below their NAV as it appears, given the recent spike in volume, they have become hedging and trading vehicles.  These instruments are extremely oversold and rarely do we see an RSI of less than 10% on any traded security.  If they don’t experience even just a “dead cat bounce” here, we suspect the muni market is in serious trouble.

California is in the process of issuing $14 BN of new debt into this meltdown.  The state launched $10 BN of short-term revenue anticipation notes, RANs, on Monday, with two series maturing on May 25, 2010 and June 28, 2011. California Treasurer, Bill Lockyear, said 44% of the issue was circled on the first day, which is weaker than the September 2009 RAN sale, which sold 61% of the $8.8 BN offering on its first day.   The state is hoping to issue the RANs at a yield of 1-1 ½%.  The final yields will be set on Wednesday.

After the completion of the RANs, the state will sell $2 BN of Build America Bonds on Thursday followed by $1.75 BN of conventional tax-free bonds.   The sale of these issues should be monitored closely to determine whether the sovereign debt concerns of Europe are spreading into the U.S. muni market or the recent volatility is just a case of serious indigestion.

Debt service payments now account for 7.13% of California’s General Fund receipts , up from 4.14% in fiscal 2006-7.  The state has $76 BN of long-term bonds outstanding and a projected shortfall of over $100 BN for the next five years, not counting its structural underfunding of pension obligations.   California’s failure to deal with its structural fiscal problems may be finally “coming home to roost.”  Stay tuned!

Related Articles
Bad timing: California seeks bond buyers amid rout in muni market – LA Times
Tax-Exempt Muni Bonds Tumble – WSJ
Miller Tabak’s Pietronico Says Muni Supply Surge Means Bargains – Bloomberg
John Hussman: The Muni Market Has Fallen Off “The Cliff” And Equities Are Next – BI
Calif. Market Close: Tax-Exempts Finish Weaker – Bond Buyer
ETFs Disagree With Municipal Indexes – Bond Buyer

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