Introduction: Recent Trends in the Bond Market · 2012. 3. 13. · PRESENTATION3 Introduction: Recent Trends in the Bond Market Kellogg West Conference Center Pomona, California March

PRESENTATION3

Introduction: Recent Trends in the

Bond Market

Kellogg West Conference Center Pomona, California

March 14, 2012

California Debt and Investment Advisory Commission Debt Essentials Seminar

CDIAC Debt Essentials 1

Nikolai J. Sklaroff, Director Wells Fargo Securities

oPublic Finance Investment Banker

oFormer CDIAC Debt Technical Advisory Committee member

oPublished “California’s Credit Crisis: Financing Credit Facilities After the Financial Storm” in Debt Line in December 2009

Speaker


Key Trends and How they are Affecting Issuers

Interest Rates

Credit Trends

Players

Regulation

What’s it All Mean to You


From “Boring Bonds” to … 2012


Trend 1: Low Rates

Historical “AAA” MMD

Source: Municipal Market Data. As of March 8, 2012.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%30-Year "AAA" MMDAverage

Average = 5.29%

Current = 3.30%


Why: Supply is Down

Historical New Money Issuance in California

Source: Thomson Reuters SDC Platinum. As of March 8, 2012.

0

10

20

30

40

50

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

$ bi

llion

s


Why: Demand is Up Again

-1,500

-1,000

-500

0

500

1,000

1,500

3/2/11 4/2/11 5/2/11 6/2/11 7/2/11 8/2/11 9/2/11 10/2/11 11/2/11 12/2/11 1/2/12 2/2/12

Money Market Flows (2011 to Present)

Sources: Thomson Reuters, Lipper FMI. As of March 2, 2012.

Net inflows of $12.8B during past 6 months Net inflows of $6.3B YTD

in 2012 Net outflows of $24.1B

since Nov. 2010


Result: Refunding Opportunities

Historical Refunding Issuance Volume and 30-Year “AAA” MMD

Source: Thomson Reuters SDC Platinum and Municipal Market Data. As of March 8, 2012.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

0

50

100

150

200

250

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

30-Y

ear "

AAA"

MM

D

Annu

al R

efun

ding

Par

($bi

llion

s)

Annual Refunding Volume

30-Year "AAA" MMD


A Renewed Focus on Refundings

2006 California Issuance

Fixed80%

Variable20%

Fixed89%

Variable11%

2011 California Issuance



0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041

"AAA" INSURED "AA" "A" "BAA"

Trend 2: Credit Spreads Remain Wide for the Weak

* Represents average spread across the 30-year curve. Source: Municipal Market Data. As of March 8, 2012.

1.76%* separates the top and bottom “investment grade”

bonds today

Interest Rates by Credit Ratings Today


0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1/1/07 6/1/07 11/1/07 4/1/08 9/1/08 2/1/09 7/1/09 12/1/09 5/1/10 10/1/10 3/1/11 8/1/11 1/1/12

%

Year

30-Year "Aaa" MMD 30-Year "Baa" MMD

Why: Credit Flight Follows Credit Turmoil

Source: Municipal Market Data. As of March 8, 2012.

260 bps

172 bps

Credit spreads were widest in 2009 and have since narrowed but are still wider

than pre-downturn

Historical Credit Spreads

33 bps


Result: Strong Credits Have the Best Market Access

Historical California Issuance by Underlying Credit Rating

* 2012 year-to-date as of March 8, 2012. Source: Thomson Reuters SDC Platinum. Ratings based on underlying long-term rating by Moody’s. As of March 8, 2012.

16% 17% 16% 14%20%

8% 12%

24%30%

37%

21% 17%9% 6% 4% 7% 6% 6%

18%13% 12%

23%32%

21%29% 29%

43%

30%

47% 46% 49%26% 25%

23%

9%

27%

16%14%

17% 7%

11%

8% 12%

10%5%

4%7% 7% 5%

1%3%

36%

29% 11% 31%24%

28%

34%

43%

24%32%

34%

1% 1%1%

3%

3%

5%8%

2%1%

1%

2% 3%

2%

7%

1%

2% 2%2%

2%1%

1%

5%

6%

2% 4%

8%

1%14%

12% 1%

1%

57% 56% 60%

74%

50%

71%66%

57%62%

51%

70% 68%

79% 82%92%

85% 85% 87%80% 83%

51%43%

51%45% 42%

34%

22%13%

18% 22%16%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012*

AAA/AA A BBB Below IG


Trend 3: The Disappearance of Bond Insurance

Source: Bloomberg. As of March 8, 2012.

Insurer Moody’s S&P Fitch

Aa1 Stable

AA+ Negative Not Rated

Aa3 Negative Outlook

AA- Stable Withdrawn

Withdrawn Withdrawn Withdrawn

Baa2

Negative

BBB Outlook Developing Withdrawn




Ca Outlook Developing Withdrawn Withdrawn


Result: More than 80% of Market Unenhanced

Source: Bond Buyer. As of March 6, 2012. 2012 represents year-to-date information.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012*

Unenhanced

Other Guarantees

Standby Purchase Agreements

Letters of Credit

Bond Insurance

Issuance by Credit Enhancement


Trend 4: An Industry Love-Hate Relationship

Moody’s Investors Service

Standard & Poor’s

Fitch Ratings


Why: What’s Been Happening

Aaa/AAA rated bonds that were downgraded or defaulted

“Global Ratings Adjustments”

Downgrades and Readjustments

Policy Changes


Result

Underlying Ratings More in Demand than Ever

Investors Make Own Rating Judgments

Need to Reach Investors Directly

Pressure for Continuing Disclosure / Access


Trend 6: Dramatic Decline in VRDOs

Historical Variable Rate Issuance

0

20

40

60

80

100

120

140

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

($bi

llion

s)

VRDO ARS

Source: Thomson Reuters SDC Platinum. Consists of ARS, Variable Short, Variable Long and Variable. As of March 8, 2012.


Why: Changes in the Bank Industry

January 1, 2007 June 15, 2

Source: Bloomberg. Company websites. Market Cap as of March 8, 2012; Ratings as of February 16, 2012.

January 1, 2007 March 8, 2012

Total Market Capitalization

15

22

23

24

24

30

42

43

64

67

75

82

85

90

93

115

120

120

125

168

240

274

- 50 100 150 200 250 300

KeyBank

PNC

National City

Bear Stearns

BB&T

SunTrust

Lehman Brothers

WaMu

US Bank

Deutsche Bank

Credit Suisse

Merrill Lynch

Morgan Stanley

Goldman Sachs

Barclays

Wachovia

Wells Fargo

UBS

RBS

JPMorgan

Bank of America

Citigroup

8

12

20

31

33

36

44

46

47

53

56

60

87

99

154

165

- 50 100 150 200

KeyBank (A3/A-/A-)

SunTrust (A3/BBB+/BBB+)

BB&T (A1/A/A+)

PNC (A2/A/A+)

Credit Suisse (Aa1/A+/A)

Morgan Stanley (A1/A/A)

Deutsche Bank (Aa3/A+/A+)

RBS (A2/A/A-)

Barclays (Aa3/A+/A)

UBS (Aa3/A/A)

US Bank (Aa2/A+/AA-)

Goldman Sachs (A/A)

Bank of America (A2/A/A)

Citigroup (A1/A/A)

JPMorgan (Aa1/A+/AA-)

Wells Fargo (Aa3/AA-/AA-)


Changes in the Letter of Credit Industry

Source: Thomson Financial and company websites; True Economics Rankings. As of January 12, 2012.

Top 20 LOC Banks in 1991 Top 20 LOC Banks in 2001 Top 20 LOC Banks in 2011

Rank Bank Principal Amount

Mkt. Share

National Flag Rank Bank Principal

Amount Mkt. Share

National Flag Rank Bank Principal

Amount Mkt. Share

National Flag

1 Mitsubishi Bank 738.2 7.8 1 Bank of America NT&SA 1,268.5 9.8 1 J P Morgan Chase 4,051.3 21.5

2 Sumitomo Bank 701.7 7.4 2 SunTrust Bank 906.3 7.0 2 Citibank 3,618.0 19.2

3 Societe Generale 576.2 6.1 3 US Bank National Association 525.9 4.1 3 Wells Fargo Bank 1,679.1 8.9

4 Industrial Bk of Japan Tr Co. 574.9 6.0 4 Allied Irish Banks 491.6 3.8 4 Bank of America 1,085.2 5.8

5 Morgan Guaranty 542.6 5.7 5 Bank One, NA 486.1 3.8 5 US Bank 677.3 3.6

6 Swiss Bank Corporation 516.4 5.4 6 Wachovia Bank 465.2 3.6 6 Govt Development Bank for PR 669.2 3.5

7 AMBAC 493.2 5.2 7 Landesbank Hessen-Thuringen 436.0 3.4 7 Royal Bank of Canada 478.9 2.5

8 National Westminster Bank PLC 427.0 4.5 8 Bayerische Hypo Vereinsbank AG 413.0 3.2 8 KBC Bank 378.6 2.0

9 FGIC 423.0 4.5 9 The Chase Manhattan Bank, N.A. 379.0 2.9 9 PNC Bank NA 328.3 1.7

10 Citibank NA 320.4 3.4 10 Fleet Bank NA 337.0 2.6 10 Bank of Tokyo-Mitsubishi UFJ 265.6 1.4

11 Student Loan Marketing Asoc 313.3 3.3 11 Firstar Trust Company 320.9 2.5 11 Mizuho Financial Group 260.7 1.4

12 Union Bank of Switzerland 305.2 3.2 12 The Bank of New York Mellon 310.9 2.4 12 Northern Trust Company 234.4 1.2

13 Sumitomo Trust & Banking 299.6 3.2 13 Bayerische Landesbank 296.4 2.3 13 The Bank of New York Mellon 221.2 1.2

14 The Fuji Bank, Limited 287.4 3.0 14 First Union Natl Bk of Georgia 233.1 1.8 14 Bank of Nova Scotia 212.0 1.1

15 Bank of Tokyo 253.0 2.7 15 Barclays Bank PLC 224.6 1.7 15 Scotiabank Europe 205.4 1.1

16 Credit Suisse 187.6 2.0 16 PNC Bank NA 208.3 1.6 16 Bank of Montreal Trust 150.0 .8

17 Toronto-Dominion Bk & Tr Co. 165.9 1.7 17 US Bank 202.2 1.6 17 Union Bank 136.6 .7

18 The Sanwa Bank, Limited 164.1 1.7 18 HypoVereinsbank Luxembourg SA 200.0 1.5 18 TD Bank NA 132.8 .7

19 Barclays Bank PLC 152.1 1.6 19 AmSouth Bank NA 199.0 1.5 19 FHA 127.5 .7

20 The Tokai Bank, Ltd. 134.9 1.4 20 Branch Banking & Trust Co 191.1 1.5 20 Barclays Bank PLC 124.4 .7

Industry Total 9,510.5 100.0 Industry Total 12,946.0 100.0 Industry Total 18,885.4 100.0


Select Credit Bank Ratings and Trading Relationships

Long-Term Ratings

Bank Moody's S&P Fitch

Wells Fargo Bank Aa3 AA- AA-

J.P. Morgan Aa1 A+ AA-

U.S. Bank Aa2 A+ AA-

Northern Trust Aa3 AA- AA-

Bank of America A2 A A

BB&T A1 A A+

Citibank A1 A A

PNC Bank A2 A A+

Goldman Sachs - A A

Compass A3 A- A-

Keybank A3 A- A-

Morgan Stanley A1 A A

Fifth Third A3 BBB+ A-

SunTrust A3 BBB+ BBB+

Regions Ba2 BBB- BBB-

Source: Bloomberg as of February 16, 2012.


Changes in the Letter of Credit Volume

0

10

20

30

40

50

60

70

80

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

($bi

llion

s) National CA

Historical LOC Issuance



General Trends in Credit Enhancement

o Banks retaining capacity for existing clients

o Pricing remains competitive

o Greater attention to documentation

o Top three banks accounted for 50% of volume(1)

o Number of banks providing enhancement has declined since 2008, with little activity from foreign banks

(1) Thomson Financial; True Economics Rankings. As of January 12, 2012.


But the Stats are misleading…

While the decline in variable rate and LOC issuance is genuine, it is also vastly overstated

Significant movement to on-balance sheet enhancement alternatives: Direct Purchase by Banks

Different banks are doing the product differently and the generic term really describes multiple products

Volume significant

o Some banks buying as securities, some as loans

o Some show up in market data, much does not


Three Basic Models

Issuer Bonds*

LOC Provider

Remarketing Agent

SIFMA +/- Spread

Fee Fee Tender Option

VRDO Structure Index Floater Structure Bank Direct Purchase Structure

* Bonds purchased by Investors * Bonds purchased by Investors ** Bonds purchased by Bank

Issuer Bonds*

SIFMA +/- Spread

Issuer Securities**

SIFMA +/- Spread

‡ Under certain credit events, the Bank may accelerate repayment of the securities


0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Current = 0.14%

Average = 2.66%

Trend 7: Low Variable rates

Period of extraordinarily low rates

High: 7.96% Low: 0.06% Average: 2.66% Current: 0.14%

Source: Bloomberg. As of March 8, 2012. Average data based on data from 1/1/1990 through 3/7/2012. Current as of 3/7/2012.

Historical SIFMA


Why: Rare ‘Moment of Clarity’

Unique clarity from the Fed’s recent outlook for rates

Short-term rates are expected to remain low through 2013

Source: Bloomberg. As of March 2, 2012.

Economist Outlook on the Federal Funds (as of March 2, 2012)

Median Survey

BofA/Merrill Lynch

Moody's Cap MktGoldman Sachs

Wells Fargo

0.00%

0.25%

0.50%

0.75%

1.00%

1.25%

1.50%

Current 1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013 2Q 2013


Result: Changing Borrowing Dynamics

Assumptions: 2007 SIFMA average of 3.62%; 2012 SIFMA Average of 0.18%; 2007 Credit Costs of 0.20%; 2012 Credit Costs of 0.80%; 2007 Remarketing Fee of 0.08%; 2012 Remarketing Fee of 0.12%.

Generic Variable Rate Cost Comparison (2007 vs. 2012)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

2007 2012

SIFMA Avg Credit Cost Remarketing Fee


Trend 8: Regulatory Changes

Municipal Securities Rulemaking Board

Securities Exchange Commission

Internal Revenue Service

Disclosure and Continuing Disclosure


Conclusion: Where to Next?

2012

2037

The Future of Tax Exemption vs. Tax Credits

National Infrastructure Bonds?

Basel III and Role of Banks?

Rates and Economic Recovery?


Questions and Follow up

Nikolai J. Sklaroff Public Finance Investment Banker Wells Fargo Securities 550 California Street, 10th Floor MAC A0112-108 San Francisco, CA 94104 415-222-6825 Direct 415-608-5467 Cell 415-975-7537 Fax [email protected]


Disclaimer This message is a product of the Municipal Products Group, and is not a product of the Wells Fargo Securities, LLC Global Research Department. The views of the Market Strategist may differ from that of the Global Research Department. Publications of Wells Fargo Securities, LLC’s Global Research Department may be viewed at www.wellsfargo.com/research. This communication is for informational purposes only, is not an offer, solicitation, recommendation or commitment for any transaction or to buy or sell any security or other financial product; and is not intended as investment advice or as a confirmation of any transaction. The information contained herein is (i) derived from sources that Wells Fargo Securities ("WFS") in good faith considers reliable, however WFS does not guarantee the accuracy, reliability or completeness of this information and makes no warranty, express or implied, with respect thereto; and (ii) subject to change without notice, and WFS accepts no liability for its use or to update or keep it current. Products shown are subject to change and availability. WFS and/or one or more of its affiliates may provide advice or may from time to time have proprietary positions in, or trade as principal in, securities that may be mentioned herein or other securities issued by issuers reflected herein; or in derivatives related thereto. WFS is the trade name for certain securities-related capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, member NYSE, FINRA and SIPC, and Wells Fargo Bank, National Association. Municipal Derivatives solutions are provided by Wells Fargo Bank, N.A. This communication is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations and does not constitute advice within the meaning of Section 15B of the Securities Exchange Act of 1934. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment, and other aspects of this communication. Neither WFS nor any person providing this communication is acting as a municipal advisor or fiduciary with respect to any transaction described or contemplated therein unless expressly agreed to in a written financial advisory or similar agreement.

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Introduction: Recent Trends in the Bond Market · 2012. 3. 13. · PRESENTATION3 Introduction: Recent Trends in the Bond Market Kellogg West Conference Center Pomona, California March