Gas debt hit as banks lose government guarantees
Fading government support for big lenders sees ratings cut on bank-backed natural gas bonds
The fading notion that the largest US finance companies are too big to fail led Moody's Investors Service to cut ratings on US$5.5 billion of bank-backed debt used to buy natural gas. Investors see the bonds as too cheap to pass up.
Municipalities use the tax-free securities, dubbed prepaid gas bonds, to trim fuel costs. Moody's reduced grades on some of the debt on November 18 to as low as two steps above junk. That was four days after it cut Goldman Sachs, JP Morgan Chase and Morgan Stanley on the view that the government is less likely to help the banks repay creditors in a crisis.
Gregory Steier, head of tax-exempt fixed income at Brown Brothers Harriman in New York, said he bought some gas debt in recent months, seeing an opportunity in securities with higher yields than company debt. The bonds had also been dumped by mutual funds facing record redemptions, he said.
"Forced selling by funds led to many opportunities to purchase good-quality securities at attractive levels," said Steier. "These tax-exempt bonds were available at higher yields than comparable debt backed by the same underlying banks."
The securities are an example of how Wall Street intersects with the US$3.7 trillion municipal market. Public utilities from California to Georgia used the proceeds to lock in prices and limit vulnerability to market fluctuations. The safety of the debt is linked to the creditworthiness of the banks, which typically serve as buyers-of-last-resort for resale of the bonds.
Regulators have been preparing rules and procedures that seek to allow the government to wind down even the largest financial companies without taxpayer assistance.
Moody's this month cut the senior holding company ratings one level for Goldman Sachs, JP Morgan and Morgan Stanley. As a consequence, the company also lowered nine gas prepayment bonds tied to the banks' credit, including issuers from California, Indiana and Texas.
There is a precedent for this corner of the municipal market to be roiled by Wall Street developments. The 2008 bankruptcy of Lehman Brothers led to the default of US$709 million of bonds it guaranteed for one group of utilities, Main Street Natural Gas.
For investors, the gas debt has appeal when compared with company borrowings with a similar rating and maturity.
Prepaid gas bonds issued by Southern California Public Power Authority with backing from Goldman Sachs and maturing in November 2033 traded at an average yield of about 5 per cent on Monday. For top earners, that's a taxable equivalent of about 8.3 per cent. A comparable corporate bond would yield about 5.3 per cent.
"They're still cheaper than corporates," said Mikhail Foux, a credit analyst at Citigroup in New York.
Investors such as Brown Brothers have also been lured as some funds sold the bonds during the worst performance for local debt in five years. Municipals have lost 2.3 per cent this year, on pace for their first losing year since 2008, Standard & Poor's data shows.
Fixed-income assets have sold off amid bets that a growing US economy will lead the Federal Reserve to slow the pace of its monthly bond buying.
Individual investors have pulled US$52.5 billion this year from municipal mutual funds, compared with an addition of US$48.5 billion in the same period of last year, according to Lipper US Fund Flows data.
For some bondholders, the additional scrutiny banks are receiving is also a reason to favour the gas debt.
The government is working on ways to ensure that creditors take the hit from banks' losses rather than public funds, seeking to assure taxpayers that banks are not too big to fail. Regulators have also been passing rules that ensure banks improve the amount and quality of their capital as a cushion against losses.