Q: What is your prediction about bond volume in 1994? Do you thin it's going to taper off and what kind levels do you see for 1995?
A: Well, it quite clearly is going to taper off on the basis of the advanced refundings. And since advance refundings or conventional refundings account for two-thirds of your volume, the cutback in that is obviously going to be severe.
Our concern also is the steady downward drift that we've seen in new issues starting in '91, off slightly in '92, and it appears going to be off even more materially in '93.
Q: Can you predict a level in 1994?
A: In simply new-issue [volume], you clearly have the potential for $120 billion to $130 billion, and that says no more than that some new-issue involvement [this year] has been pushed Aside by the refundings.
That means that your wild card is: what's the extent of refunding and advanced refunding activity? Here it is difficult to come up with numbers that are anywhere near as big as they are [now].
The number could be as high as, say, $70 billion to $80 billion, which would give us a year of $200 billion. It could be as low or low enough in combination with lower totals for new-issues to bring us down to the $160 billion to $170 billion range.
But between that high and that low, $200 billion and $160 billion, you're talking about a market that's looking at a cataclysmic loss in volume. Think back, if you will, on the year where we had the big drop, which was '85 to '86. In that year you lost maybe 25% of your volume.
Q: What concerns you about the upcoming drop?
A: Sometimes we get so wrapped up in the numbers, we're failing to look at the independent elements of what goes into this. Not the least of which for us is, what is it that's motivating the people who nominally are going to be selling the new-money issues.
Here we look especially at the recurring issuers who have fixed capital budgets, do three- to six-year planning; they can tell you with reasonable certainty that this is what we're likely to be selling in '98 for planning purposes. Good operations, run clean, probably either essential utilities or well-run cities.
We're finding here that the pressures of operations coupled with needs to keep both tax costs and utility costs low has resulted in a general disinclination to have capital budgets that do a whole lot more than what absolutely has to be done. Further, a lot of the things that absolutely have to be done are things that are done as a result of mandates, which is the toughest way in the world of getting public support.
I'm thinking here particularly of the clean water, the sewer-related financings.
Items that come down from the feds or the state - it's not really a strong base for coming up with new issues, new-money new issues.
The world is talking to us. It's subtle, little drops at a time, but that's the shift that we're seeing taking place.
Further, if you look through the calendars here on size of refundings versus size of new-money, you're clearly talking about two different worlds.
So we're liable to find ourselves a lot more engrossed in smaller deals, a lot more obviously water and sewer because that's related to the mandates, and a lot more, proportionately, public facility financing.
Q: You think the market volume has pretty much exhausted itself and is going back to its roots - smaller deals?
A: That's well phrased, right to the point. Because certainly if the bankers had anything to do with it, that would not be the case. And to some extent, we've seen new levels of banker creativity in the course of the last 20 years.
Q: What about the pressure of infrastructure needs, the roads that need to be repaired, housing for the poor? What happened to all that?
A: Appeals to infrastructure needs and the demands are, as often as not, thinly masked requests to have somebody else take and pay the costs on this.
The cries come the loudest from jurisdictions that have really a lousy history of capital budgeting. Unfortunately, those numbers, I suspect, are growing larger, but it does make the better cities - as a general rule, these are American cities that run from 200,000 to maybe 350,000 people - where they do practice this regularly and they're concerned about infrastructure.
But it expresses itself every year in systematic bonding, plus some allocation of money out of current account.
But what has happened in the vast majority of your larger jurisdictions is it's like a repeat of what's happened in the last 15 years. Operational demands have become simply overwhelming to the point where we find severe pressures on the most basic of local government functions, which is education. Education, of course, is now rearing its head in totally new ways with court mandates, but it nevertheless is something from which there is no escape.
Certainly, high levels of social welfare costs are dominant in many areas, at the same time as infrastructure utility systems are eroding in your older jurisdiction&
Now, you put all those together and you say, boy oh boy, they've got all these needs, but what does debt service look like when you get into a situation like that? The answer here is New York City.
Now I happen to think that New York City has been extremely well run fiscally ever since the turnaround in what was it, '81, when they finally got back totally on their feet.
But New York City is looking at debt service that's going to be running 16%, maybe 17% of budget somewhere out there. When you get up to numbers like that, where there are heavy operational demands,. you're talking about real pressures. And I can't say that these are matters of active concern, but they're nevertheless out there and they're clearly on the minds of the people in civic positions who are making these decisions, and that's what really matters.
Q: Because of the new rules on campaign contributions, do you think public officials may decide not to do certain deals? Will it be a factor that will affect the way the industry's going to do business and how the dealers deal with public officials? Or do you think that is not going to have any effect at all?
A: Well, it's so widespread that to say it's a factor that win have no impact is to be really sort of Pollyannish.
I have no doubt that relationships that stem from political support and involvement do results in deals being done. You have to be ultimately naive [not] to feel that way.
To the extent that there's less interfacing between bankers and issuers, that clearly will have some negative effect on volume.
In other words, I do think these relations frequently result in financing.
Q: Are there deals out there now that hearken back to concerns about the Washington Public Power Supply System? Is there anything you see on the horizon, another WPPSS? Something that people should be watching for either by name or by a kind of issuer or bond that's out there, something maybe issued in the last 10 or five years?
A: Specific issues, no. Types of issues, most certainly.
I think Brevard [County) was a lesson. The fact that you could come off with a 52% to 48% vote on what would have been to me a suicidal act is endemic of where we are.
And I really think that your problems are going to be on smaller local issues, which if you look on it, you don't have much of a default history as you do on rated bonds.
Q: When you say small or local issues, though, are you talking about a GO or a certain kind of revenue bond?
A: Very seldom GOs. They're hospital and special project bonds, IDBs. Incidentally, all are still part of the milieu here, because if you were to say what one area of finance is probably going to have the most potential demand put on it in view of demographic patterns, it would be life care centers.
[Then] ask yourself, what's the toughest kind of security that we sell in the municipal market right now? Life care centers.
I think that sort of embodies a lot of what we were talking about.
Q: You mentioned smaller IDBs as potential concerns. What else do you see? How do you determine that these are the things we should avoid or these are the things we should be careful about?
A: For starters, remember where I am and what I'm doing. I don't see a lot of the really gamy private-activity issues that come through on private placements, most of which would be varieties of IDBs.
They simply don't cross our desks. About the toughest thing that we see would be smaller hospital deals that seem to function in a world of their own. They're rural and you know you've got concerns for how they're going to be, if they're going to be viable over time with the consolidation that's taking place.
This is going to sound like a strange thing to say. I think that what has happened in the course of the last three to four years, with the relative de-emphasis on new money and heavier amounts of refundings, is this: A lot of outstanding issues have tended to mature, and credits that potentially were weak - start-up hospitals being an outstanding example or [hospitals undergoing] vast expansion - have now sort of got a track record. This is really sort of a high water point for absence of deals that look like they're going to go in the tank.
Why? Simply because there hasn't been intense pressure to come up with new varieties of new-money financing in the course of the last couple of years.
Now that'll change.
And yet, looking at the authorized purposes, we have none of the exposure that we had back in '83, '84, and '85 before you had limitations on private-activity bonds. I mean, just think about what you're saying. If you're going to take and do financing for highly speculative, local industrial facilities, you've got to make it through whatever the approval authority is in your state to bring those to market. Now, that process in and of itself, it seems to me, weeds out a lot of these things that we would in just the normal course of things have seen in the mid-80s.
I guess.what I'm saying is that I think the private-activity caps that we now live with are working, but not to the point where you still don't see disproportionate numbers of failures in IDBs.
Q: What about Denver International Airport?
A: I think Denver is of interest, simply because it is to the best of my knowledge the only really major financing that's now coming on line. Obviously there are great concerns about the overall human costs in what appears to be an uneconomic facility. But it is nevertheless a monopoly facility where we have seen replays of this in the past, nothing quite this grand and this big, but nevertheless, one for which sufficient forces will be brought to bear to make it work.
I can't say we're not concerned. Obviously we are concerned, but we think that what we're seeing right now in Denver is nothing more than what normally happens in the final stages of a massive public project coming on line.
Q: Hypothetically speaking, let's say you were to take all insured bonds out of the disclosure equation? Of the roughly 1.2 trillion of outstanding debt, between 20% and 30%, I believe, is insured. In the disclosure process going on at the federal level, do you think it would be a good idea to omit insured bonds from the equation because they're insured?
A: I don't concur with that.
Q: Why?
A: Because you are in effect interposing a private intermediary in the stream of communication that comes from public bodies that should go to public citizens.
Now, I don't care how talented they are in between. This has got overtones of, don't worry about it, the local bank is taking care of it. Oh yeah, and anybody who's an analyst has got real problems with that, I would suspect.
As a matter of fact, one of our concerns right now is that we obviously did a lot of stuff in the secondary, and unfortunately the market does have a tendency to accept and trade on the basis of rating.
When we want to find out detailed information on a deal that has been insured, nine times out of 10 the available information is nowhere near as good as what we can get on the thing that trades on its own.
Now you might look at that and say, well what difference does it make? Okay, because per what you said, insurance is there to protect, but we find that for professional buyers, they want to know things like, what's the structure of this as it relates to other financing? Is there anything unique about this in terms of what the underlying project is all about?
Q: Let's touch on derivatives now. What sort of challenges do derivatives pose for analysts like yourself in particular and analysts that work with portfolio managers. if"hat are the questions that you ask about derivatives when they come up and why?
A: Well, let me start off by saying we have the same quandary. on questions that we have talking about Executive Life or Mutual Benefit. It was part of the lore of the industry which I admit many of us accepted that this source of credit was not subject to serious question and so we have practice in knowing that we don't always know the questions to ask.
The difficulty on derivatives is that we are precisely in that position again because we are in effect at the analytical level called to draw judgment upon subsequent credit status of third parties who are involved in derivatives about whom we have no particular knowledge. That means many of us sense that we may be working with time bombs, but we're doing it with essentially no disclosure whatsoever as to what the nuances are of the specific transactions, and most of what you're getting right now is anecdotal.
Now for us, it's been simple because our firm's posture on floaters and the short-term variables, the most basic derivatives, is that we never really got actively involved in this, and I think part of the reason is that so much of our customer base is retail. I can't say it doesn't cause us concern, and yet you have that feeling that the net effect of this is clearly going to be disruptive for the industry and it's the next item of really bad news that impacts municipal securities.
Q: & A:
The landscape studied by municipal analysts has changed dramatically in the last 15 years.
Where once plain vanilla credits and revenue bonds dotted the surroundings, there are now complicated derivatives, lock-box revenue bonds, multidimensional conduit financings, back-door financings, concerns about secondary market disclosure, the legacy of WPPSS, special district bond issues, and certificates of participation that hang precariously on the whims of voters.
These changes have created new challenges for municipal analysts. The demands on them have increased tremendously. Not only do they study and prepare reports on credits, but they must work well with their trading and underwriting desks, keep up with the changing status of complex credits, and deal with more demanding and sophisticated retail and institutional clients.
Among the ranks of municipal analysts is Robert W. Chamberlin, a veteran of 30 years and, to many, one of the deals of the industry.
Chamberlin, who began his career with B.J. Van Ingen & Co. in 1963, joined Dean Witter Reynolds Inc. in 1967 and has been there ever since. In an interview with managing editor John J. Doran, Chamberlin, a senior vice president, offers his wide-ranging views on everything from bond volume to derivative products.
