State and city governments have joined investors in pushing the US Federal Reserve and the White House for specific measures to support the $4tn municipal bond market, which has been shaken by the recent downturn.
Under the $2tn stimulus law enacted late last month, the US central bank has committed to develop a programme to help local and regional governments struggling to manage the coronavirus outbreak and the economic damage it has caused. The aid could include lending cash to municipalities, especially to help school districts or other issuers that rely on one-time tax payments. As part of that effort, the Fed has also promised to find ways to steady the muni bond market, which has seen some extreme price swings since late February.
But as yet, there have been few details on this unprecedented Fed incursion, and little clarity on what the central bank will consider buying and how much credit risk it is willing to take on. The uncertainty has rippled through the normally staid muni market, with yields on debt maturing in 10 years remaining elevated and investors continuing to yank cash from muni bond funds, according to Lipper.
Many municipalities have put off issuing new debt, as a result. Triple A rated San Francisco, for example, has postponed a $230m “general obligation” bond as well as a special $50m bond to strengthen the seawall on the Embarcadero waterfront.
The market is harder to navigate now than it was in 2008 and 2009, during the grip of the last financial crisis, said Anna Van Degna, director of public finance in the San Francisco controller’s office. “It is crazy that even the higher-rated credits are having challenges entering the market,” she said.
All states that collect personal income taxes have extended filing deadlines while others, such as Pennsylvania, have rolled back dates for collecting corporate tax payments by several months. But analysts warn that such delays in income collection pose significant risks to muni issuers’ creditworthiness.
Moody’s this month gave New York state and city a negative credit outlook, citing the coronavirus-related hit to tax revenues. Rating agencies may soon go a step further and start downgrading large muni issuers, Vikram Rai, head of municipal strategy at Citigroup, warned in a recent note — further destabilising a fragile market.
Participants say that until there is more clarity from policymakers, the market will struggle to function.
“The market is looking for direction from the Fed,” said David Hammer, head of municipal bond portfolio management at Pimco, adding that he expects the central bank to eventually buy longer-dated munis with maturities of no more than five years.
The Fed should focus its efforts on supporting municipal bonds that rely on one-time tax payments, said Ben Watkins, director of Florida’s bond finance division. “That should be the primary focus of the Fed in terms of relief they could provide.”
Mr Watkins said that his preference would be for the Fed to provide the muni market with a “backstop” as it has in the money market, with a new facility providing loans to banks secured by assets from money-market mutual funds. “That could be done expeditiously,” he said.
Local mayors and treasurers have joined the chorus, writing in a March 31 letter to Fed chairman Jay Powell and Treasury secretary Steven Mnuchin that they are expecting quick relief. If efforts come up short, “we fear that the market will once again take a turn for the worse,” the writers said.
To date, the Fed has agreed to allow market participants to use municipal debt as collateral for loans. But Matt Buscone, co-head of portfolio management at Breckinridge Capital Advisors, said that was an insufficient fix.
“Pledging collateral doesn’t help the long-end; it just eases strains at the short-end of the curve,” he said. “The market is saying, ‘we need to see direct intervention from the Fed.’”
Mr Rai of Citi said that direct purchases of munis by the Fed would bring challenges, as the central bank would run the risk of accusations it is helping certain states and cities over others.
Still, he added, political considerations should not prevent the Fed from acting quickly.
“Coming late is as good as not coming at all,” he said.