Muni-bond interest rates rise on default worries

As Smithfield prepared to sell $7.65 million of bonds on the municipal-bond market last month, Finance Director Randy Rossi wasn’t sure what to expect.
Days before, the rating agency Standard & Poor’s had upgraded the town’s bond rating one notch to AA, but Rossi had received advance warning of heightened anxiety in the marketplace due to fear among investors of muni-bond issuers defaulting.
In the bond market, skittish investors usually lead to lower demand and higher borrowing costs.
“The climate in Rhode Island has been tough, with the Central Falls [receivership], and [federal legislators] looking at changing the law on allowing state bankruptcy filings,” Rossi said last week.
The bond offering went forward, and in hindsight, it was the right decision, Rossi said.
The $6.27 million of nontaxable, 20-year bonds Smithfield sold last month (the town also sold $1.38 million of taxable bonds) attracted enough attention from investors that the interest rate was set at 3.86 percent, far lower than the 5.39 percent projected by the town’s bond adviser.
“I think it was our long history of financial stability,” Rossi said.
Going forward, it remains to be seen whether Smithfield’s experience will be the norm or the exception.
Typically, state and local governments rely on the municipal-debt market to raise money for reasons ranging from smoothing out cash-flow issues to financing road and school projects. But in recent months, the municipal-debt market has been roiling with concern that it could be hit with defaults as muni-bond issuers such as cities, towns and even states grapple with large budget deficits and other growing liabilities.
Rhode Island has garnered special attention lately because of its high debt load, and because of the revelation that the state is part of a U.S. Securities and Exchange Commission investigation into bond disclosures to analysts and investors.
Local advisers involved with the bond market acknowledge interest rates are on the rise, but at least one official says the market is just returning to rates and yields of several years ago, before the meltdown in the financial markets.
“Obviously, there’s still some anxiety in the marketplace – all the press about [the struggles of] municipalities and the governments has created some uncertainty,” said Robert Donovan, executive director of the R.I. Health and Educational Building Corporation, a quasi-public agency designed to provide some nonprofit institutions cost-effective access to capital through tax-exempt bond issues. “But overall, people still see municipal bonds as a good investment.” Donovan pointed to a $6.7 million bond offering that the corporation completed in early February in cooperation with Westerly and Cranston to finance school construction. The interest was set at about 4.5 percent.
Now, Donovan said, three other corporation-aided bond offerings are moving forward, including one for the Chariho School District that will be finalized in the next few months.
Investors “are digging much farther down into the individual credit quality, the underlying quality of the municipalities,” Donovan said. “But I think they’re weighing it where the market used to be.”
There’s no doubt the muni-bond landscape has changed since the subprime meltdown rattled financial markets in late 2008.
Gone are most of the bond insurers that lent their strong credit rating to bond issuers for a fee, thereby lowering interest rates. Many bond insurers were downgraded in the crisis, rendering the insurance meaningless.
While mutual funds have traditionally been big buyers of this type of debt, individual investors have been withdrawing from muni-bond funds. Institutional investors have not picked up the slack.
Last month, Moody’s Investors Service announced it will recalculate states’ debt burdens to include unfunded pension liabilities. Although the effects of that change aren’t clear yet, Rhode Island’s debt and pension liability is 13.9 percent of its gross domestic product, one of the highest ratios in the country, according to Moody’s.
Representatives of First Southwest Co., a financial firm that advises the state and numerous local communities on bond-market issues, declined to comment last week.
New General Treasurer Gina M. Raimondo is still getting a handle on the situation, ordering a review of “every aspect of the [treasurer’s office]” earlier this month. Days later, she revealed that the SEC had notified her that the agency was examining the state’s previous bond disclosures.
It remains to be seen what effect, if any, this will have when the state turns to the bond market again. Fox said the department is eying a possible bond issue in the spring. •