Market analysis from New Oak Risk Advisory & Financial Services
“Some of the self-sufficient municipal entities have adequate revenue to make their debt payments in full irrespective of the financial weakness of their municipal parent,” says Ron D’Vari, CEO and Co-Founder of NewOak.
Detroit’s bankruptcy is creating an opportunity for investors to profit from some of the city’s utility and essential services bonds. Some of these are trading at large discounts despite the high likelihood for payment of the full principal and interest. Detroit’s unconventional Chapter 9 filing has created a potential risk that some of the revenue bonds may get caught in the restructuring litigation due to potential classification as being unsecured by Orr’s restructuring plan.
Guarantees and the power to impose taxes
Revenue bonds are backed by the issuing municipality’s power to impose taxes and fees for the associated essential services in order to meet the entities bond obligations. The investors have traditionally viewed these as a secured obligations separated from other unsecured liabilities of the municipalities. However, as the Chapter 9 Federal bankruptcy process has been rare and may intersect with many other laws of the city and state (including constitutional ones), a full legal analysis leaves a risk of unexpected outcomes.
“There is a distinct difference between general obligation bonds and revenue bonds backed by economically viable entities’ revenues. The revenues should be segregated from the general funds according to the underlying documentation. The revenue bond documents are typically complex and could leave room for interpretation. Therefore, sophisticated investors may have to be review them for potential flaws and inconsistencies.”
“While the Detroit bankruptcy has created some new opportunities for distressed investors, it also has created a big issue in the confidence of the market, particularly less risk tolerant investors. While answers are still to be determined in the courts, it is clear that all muni bonds are not created equal and investors need to analyze more stressful conditions. There is a general hope that a side benefit of the credit crisis may very well be bringing back discipline to the public finance long term. This will call for better financial governance of municipalities as well as a much more disciplined public finance capital markets.
Next Fed Chairman Debate – Yellen vs. Summers?
“Last week a group of Democrats advanced a letter in support of Janet Yellen to be the next chairman of the Federal Reserve,” says James Frischling, President and Co-Founder of NewOak. “While the independent-minded Fed historically prefers to avoid being viewed as part of the political process, the move by the Democrats clearly brings the Fed into the political debate.”
Given the importance the Fed has played in not only averting a far greater financial crisis, but also in the historic rally in equities, the focus on who will succeed Chairman Bernanke is warranted. In Yellen’s favor is that she’s been the #2 Fed ranking official since 2010, has been a supporter of the accommodative monetary policy and is viewed favorably by her colleagues at the Fed as being smart headed with her hand on the pulse of the public. She has also been a key figure in the Fed’s unprecedented efforts to expand its communications strategies.
There’s talk that the position was promised to Larry Summers and given the President’s tendency to surround himself with former colleagues and friends, the Democrats that signed the letter may have felt it was necessary to announce their preference.
It also can’t be ignored that if appointed, Yellen would be the Central Bank’s first female leader in its 100-year history. With this nomination, President Obama has the opportunity to leave his mark on the Central Bank. If the President decides to nominate Yellen, the first woman to lead the Fed may also be the most qualified candidate and the overwhelmingly preferred choice. Can there really be any other choice?