MuniLand–Murky Muni Waters and Housing Finance Bonds

Transparency in the municipal bond market is opaque relative to the corporate bond market. This lack of transparency presents itself in both timely financial disclosures and price discovery. Bloomberg News highlighted the transparency risk this week in an article about a Memphis, TN multi-family housing credit that triggered a default. The story is about how a low-income multi-family housing project, managed by a not-for-profit entity, lost its federal rental subsidy. The rental subsidies were pledged as debt service to bonds issued by the not-for-profit entity for the purchase of the apartment complex. In order to receive federal rental subsidies, a property must meet and maintain safe housing standards. In this case, the not-for-profit failed to meet these federal standards, and the apartment complex was declared unlivable. Disclosure about the default was slowly disseminated. We know this because the bonds were traded in small lots of $25,000 and $50,000 to buyers at 110 cents on the dollar after disclosure of the default was released. Yes, that is correct. After the default was reported, the bonds traded as though the principal was safe, as it took several days for the rating agencies and pricing services to record the default. The bonds are now marked at 21 cents on the dollar, for about an 81% loss of principal. This story illustrates one of the risks associated with the municipal market. Municipal bonds are not all alike. In this case, the housing finance bonds were issued through a conduit authority. A conduit authority is a special purpose vehicle used by not-for-profits, private hospitals and universities that are deemed to provide some kind of public good, and that would benefit from the lower cost of financing associated with the tax-exempt market. SNWAM continues to find compelling risk reward characteristics in the housing financing agency sector, but not in structures like the Memphis, TN multi-family bonds. The Memphis multi-family bonds and similar bond structures represent significant idiosyncratic risk because of their single project nature.  We continue to overweight the housing finance sector, but ones that have single-family home loan structures, housing finance agencies with general obligation structures and state Section 8 housing authorities backed by the U.S. Housing and Urban Development Agency. 

Sources: Bloomberg News, SNWAM Research