Dexia isn’t just a Franco-Belgian basket case; it’s your basket case too. And since there’s been a bit of talk about the link between the bank and the US muni market here’s our quick take.
As the FT’s Nicole Bullock reminds us, the bank is — or at least was — intimately involved with the municipal bond market.
Dexia exited from many US activities after its 2008 bail-out, but it has continued to back a type of US municipal debt whose interest rates reset regularly. As its position has worsened, cities or other local borrowers who have Dexia-backed debt have seen their interest rates rise.
They became popular with municipalities after the collapse of monoline insurers. In effect they allow municipalities to borrow for long-term projects at short-term interest rates. The rate on VRDOs resets daily or weekly, providing investors such as money market funds the option to sell them back or roll them over.
If investors don’t want to roll over the VRDOs, or are prohibited from doing so by their credit rating (often sub P-1 according to one municipal banker), Dexia is on the hook for the buyback. Munis — at least the smart ones — have been reducing their exposure to Dexia for months now, as the WSJ explained in an article in Tuesday’s paper, but there remains about $10bn of Dexia-backed deals according to Thomson Reuters data. The real figure is probably a little less than that.
These deals have traded much wider than benchmark VRDOs since May and have been under continued stress in the last few days. There were remarketings on Wednesday and there are some more on Thursday. Average rates on Dexia-backed bonds rose by around 25bps to 2.75 per cent according to Thomson Reuters (a good 2.5 per cent above similar benchmark munis), which further suggests that these problems have been largely priced-in.
Indeed, the sense of this being a small negative for the muni sector is prevalent throughout this Bond Buyer article, published Thursday. It does though make you wonder why it’s taken some local governments so long to restructure, and whether there could be a few isolated incidents of funding trouble.
Unsurprisingly, the advice from municipal bond desks is to stay clear of the Franco-Belgian bank (from a presentation by a leading US bank):
We do not anticipate that Dexia’s trading value will improve in the foreseeable future.
Update (12:18pm New York time): Cate Long has a post on all things Dexia and municipal over at her Muniland blog. She’s looks at the underlying data and asks a very good question:
I had tweeted out yesterday that with Dexia’s problems being so well-known, any reasonably strong bond issuer should have already refinanced away from them. When checking for bonds backstopped by Dexia today on EMMA, I found that 336 different bond issues had gone through their weekly interest rate resets while still tethered to the troubled firm.
Some interest rates had risen a lot: the interest rate on the bonds of the high school in Perris, California had shot up from 1 percent on June 1, 2011 to 3.75 percent this week. The maximum allowable rate for the high school bonds is 12 percent, basically a muniland subprime rate. Given the 2018 maturity of the Perris bonds and their credit ratings of Aa3/A1 they should be able to refinance into fixed-rate bonds with a current interest rate of about 2.4 percent — about 1.35 percent lower than their variable rate. Why aren’t their bankers helping them do this?