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Tricumen Muni Market 23 Jan12 Public

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The municipal bond market has shown more resilience than expected, with defaults lower than predicted. While bond issuance declined in 2011, secondary trading volumes remained steady, showing investor confidence. The investor base has shifted, with more trading accounts and individual investors replacing some mutual funds. Additionally, major banks have increased muni staff levels in recent years, indicating they believe defaults will remain relatively low.

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Market Update: Muni Market Muni Market Resilience:why the sell side headcount matters The muni market is under pressure, but the wave of defaults has not materialised. Three key trends suggest the outlook is cautiously positive: (1) the resilient secondary trading volumes; (2) evolution in the investor mix; and crucially - (3) muni staffing levels. In the not-too-distant past, various market observers predicted a wave of municipal bond defaults in 2011; the famous ex-bank analyst Meredith Whitney went further than most, expecting hundreds of billions of dollars worth [of defaults] in the past year. This, of course, would have caused a seismic shock to a market already struggling with the current global macro crises. On the face of it, there were valid reasons for concern: the notional volume of overall primary issuance plummeted by 30% y/y in 2011, and by 35% in the more profitable negotiated deals. Bond notional issued by US Municipalities(US$bn) 500 450 3 400 3 4 350 300 7 250 357 334 349 200 232 150 100 50 53 58 73 61 0 2008 2009 2010 2011 Competitive Negotiated Private Placement Source: SIFMA The banks competing in this market most of whom have a front-row view of the credit worthiness of municipalities did not share this pessimistic view. Nor, it seems, did investors, as 30-day average secondary trading volumes decreased by mere 10% in three years to end-2011. 30 Day Average Customer Notional Traded (US$m) 14,000 13,000 12,000 11,000 10,000 9,000 8,000 7,000 6,000 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Source: SIFMA 1/3 23 January 2012
Market Update: Muni Market This investor base is somewhat different to that of a few years ago. Our research has found that the number of Muni-focused mutual funds has declined, while trading accounts, insurers and individual investors have grown in importance as buyers of muni securities. The growth of the retail investor base has been particularly useful for sell-side firms, as the bid-offer spreads that banks can charge retail clients partly offsets the decline in trading volumes. As a result, a number of investment banks have agreed distribution deals with brokers and private banks. A typical high yield municipal new issue might now see the distribution to investors as follows: Typical distribution for a high yield municipal new issue (mid-2011) Trading Accounts, 15% Retail, 35% Insurers, 25% Mutual Funds, 25% Source: Tricumen Finally, and in our view crucially, our analysis of Muni departments staffing levels suggests that banks are cautiously optimistic regarding the outlook. From the end of 2008 to date, the average headcount at Barclays Capital, Citigroup, JPM and Morgan Stanley actually grew; the increase was modest, but in stark contrast to 5-20% overall headcount reduction seen in other areas. We also note the steady growth of origination and banking headcount over the past three years: to us, this indicates that the investment banks closest to municipalities view the odds of imminent market collapse as being very remote indeed. Average Front Office Producer Headcount (excludes research staff) 800 700 600 222 234 230 217 500 400 300 487 471 488 497 200 100 0 2008 2009 2010 2011 Banking Syndicate Sales & Trading Source: Tricumen. Figures based on the average headcount at Barclays, Citigroup, J.P.Morgan, Morgan Stanley. Goldman Sachs and Bank of America were excluded, for reasons of client confidentiality) 2/3 23 January 2012
Market Update: Muni Market Notes & Caveats Tricumen Limited has used all reasonable care in writing, editing and presenting the information found in this report. All reasonable effort has been made to ensure the information supplied is accurate and not misleading. For the purposes of cross- market comparison, all numerical data is normalised in accordance to Tricumens proprietary product classification and may contain +/-10% margin of error. The report has been compiled for purposes of information supply only. We recommend that independent advice and enquiries should be sought before acting upon it. Tricumen Limited makes no representation, guarantee or warranty as to the suitability, accuracy, completeness of the report or the information therein. Tricumen Limited assumes no responsibility for information contained in this report and disclaims all liability arising from negligence or otherwise in respect of such information. Tricumen Limited is not liable for any damages arising in contract, tort or otherwise from the use of or inability to use this report or any material contained in it, or from any action or decision taken as a result of using the report. 3/3 23 January 2012

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Tricumen Muni Market 23 Jan12 Public

  • 1. Market Update: Muni Market Muni Market Resilience:why the sell side headcount matters The muni market is under pressure, but the wave of defaults has not materialised. Three key trends suggest the outlook is cautiously positive: (1) the resilient secondary trading volumes; (2) evolution in the investor mix; and crucially - (3) muni staffing levels. In the not-too-distant past, various market observers predicted a wave of municipal bond defaults in 2011; the famous ex-bank analyst Meredith Whitney went further than most, expecting hundreds of billions of dollars worth [of defaults] in the past year. This, of course, would have caused a seismic shock to a market already struggling with the current global macro crises. On the face of it, there were valid reasons for concern: the notional volume of overall primary issuance plummeted by 30% y/y in 2011, and by 35% in the more profitable negotiated deals. Bond notional issued by US Municipalities(US$bn) 500 450 3 400 3 4 350 300 7 250 357 334 349 200 232 150 100 50 53 58 73 61 0 2008 2009 2010 2011 Competitive Negotiated Private Placement Source: SIFMA The banks competing in this market most of whom have a front-row view of the credit worthiness of municipalities did not share this pessimistic view. Nor, it seems, did investors, as 30-day average secondary trading volumes decreased by mere 10% in three years to end-2011. 30 Day Average Customer Notional Traded (US$m) 14,000 13,000 12,000 11,000 10,000 9,000 8,000 7,000 6,000 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Source: SIFMA 1/3 23 January 2012
  • 2. Market Update: Muni Market This investor base is somewhat different to that of a few years ago. Our research has found that the number of Muni-focused mutual funds has declined, while trading accounts, insurers and individual investors have grown in importance as buyers of muni securities. The growth of the retail investor base has been particularly useful for sell-side firms, as the bid-offer spreads that banks can charge retail clients partly offsets the decline in trading volumes. As a result, a number of investment banks have agreed distribution deals with brokers and private banks. A typical high yield municipal new issue might now see the distribution to investors as follows: Typical distribution for a high yield municipal new issue (mid-2011) Trading Accounts, 15% Retail, 35% Insurers, 25% Mutual Funds, 25% Source: Tricumen Finally, and in our view crucially, our analysis of Muni departments staffing levels suggests that banks are cautiously optimistic regarding the outlook. From the end of 2008 to date, the average headcount at Barclays Capital, Citigroup, JPM and Morgan Stanley actually grew; the increase was modest, but in stark contrast to 5-20% overall headcount reduction seen in other areas. We also note the steady growth of origination and banking headcount over the past three years: to us, this indicates that the investment banks closest to municipalities view the odds of imminent market collapse as being very remote indeed. Average Front Office Producer Headcount (excludes research staff) 800 700 600 222 234 230 217 500 400 300 487 471 488 497 200 100 0 2008 2009 2010 2011 Banking Syndicate Sales & Trading Source: Tricumen. Figures based on the average headcount at Barclays, Citigroup, J.P.Morgan, Morgan Stanley. Goldman Sachs and Bank of America were excluded, for reasons of client confidentiality) 2/3 23 January 2012
  • 3. Market Update: Muni Market Notes & Caveats Tricumen Limited has used all reasonable care in writing, editing and presenting the information found in this report. All reasonable effort has been made to ensure the information supplied is accurate and not misleading. For the purposes of cross- market comparison, all numerical data is normalised in accordance to Tricumens proprietary product classification and may contain +/-10% margin of error. The report has been compiled for purposes of information supply only. We recommend that independent advice and enquiries should be sought before acting upon it. Tricumen Limited makes no representation, guarantee or warranty as to the suitability, accuracy, completeness of the report or the information therein. Tricumen Limited assumes no responsibility for information contained in this report and disclaims all liability arising from negligence or otherwise in respect of such information. Tricumen Limited is not liable for any damages arising in contract, tort or otherwise from the use of or inability to use this report or any material contained in it, or from any action or decision taken as a result of using the report. 3/3 23 January 2012