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Monday, October 10, 2005

Party's Over - Forbes.com

Party's Over - Forbes.com

NEW YORK - Cash-strapped towns and municipalities in the Gulf Coast region will inevitably turn to the bond market to help fund hurricane recovery efforts--a potential boon to investment banks, unless Congress and the Bush Administration ruin the party, which looks increasingly likely.

Already, there is grumbling among local politicians after U.S. Treasury Secretary John Snow told the Senate banking committee on Thursday that he found federal guarantees for municipal debt in the effected region "highly undesirable" and something he would oppose.

And this would be a very bad thing--for the muni bond market and certainly for the Gulf Coast, whose revival President George W. Bush himself has said is the nation's top priority.

But along with federal loans and grants, guarantees are exactly what municipal and local government agencies are asking for. Louisiana State Treasurer John Neely Kennedy says the state will meet its own obligations, thanks to money socked away in trust funds and two lines of credit he arranged. But, he says, local governments face crushing borrowing costs and little or no tax base to support debt payments.

"This is not an academic exercise," Kennedy said in a telephone interview Thursday. "We are trying to get back up on one knee."

There is $8.1 billion of local and municipal debt already outstanding in the areas affected by Katrina, Kennedy said, only half of that insured. Without a federal guarantee, those bonds could default. Snow said a federal bailout would be an "intrusion" on the markets and a disruption to the assessment of risk.

The comments have local politicians looking to state legislators for some sort of guarantee program, says Buck Landry, a managing director at Morgan Keegan, a Memphis investment bank that dominates the market for underwriting tax-exempt municipal and local bonds in the region.

The lack of a guarantee program also makes the job of the underwriter more difficult. With no guarantee, and no real way to measure how much of the tax base will come back in the near term, the bonds would not be likely to get insurance, a required element for many institutional buyers. That puts local issuers at the mercy of hedge funds and speculators. No federal guarantees "forces us to place unrated paper," Landry said. "It forces municipalities to issue unrated paper into a more limited market of buyers."

Overall, Citigroup (nyse: C - news - people ) is the top tax-exempt bond underwriter with $47.3 billion in tax-exempt debt, followed by UBS with $36 billion, and Merrill Lynch (nyse: MER - news - people ) with $24.7 billion. But regional firms often get the assignments to handle the smaller bond sales. RBC Dain Rauscher is the leader in this category, followed by Morgan Keegan and Piper Jaffray.

The profit margin for an underwriter arranging a municipal bond issue is razor thin, about a quarter of a percent, according to Thomson Financial, but that can add up. Using that measure, the total underwriters' fees on the proposed $45 billion Hurricane Katrina Impact Bond program would be more than $1 billion.

The Bond Market Association expects there to be $60-billion worth of new bonds in the coming years as a result of Katrina and Rita, whose damages are still being assessed. Some $45 billion of that could come in the form of tax-exempt bonds for private developers, known as Liberty Bonds, a program that was used in New York to redevelop the downtown area after the World Trade Center attacks.

New bond underwriting activity could be tamed by what Secretary Snow said, however. The Treasury is considering a "backstop" program, but he was vague about what that would be.

Jay Abrams, the chief municipal credit analyst at FMS Bonds, a broker/dealer specialized in tax-exempt securities, said, "We're going to have to see what comes out of this. It's hard to imagine you're going to get the issuance you need."

He noted that one-third of Louisiana's economy has been lost as well as one-third of its revenue. Bond buyers are going to have trouble imagining whether their investments will pay. "Snow has taken away the one logical backstop."

So instead, perhaps, the Gulf Coast's towns and cities will have to turn to their last resort. Congress will now have to just give them the money they need.

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