TRI DENT

MUNI CI PAL
RESEARCH
Municipal Market Weekly
Thursday, May 22, 2014
MUNIVERSES
Complacency is Never a Good Strategy
However, complacency seems to be one of the driving forces behind the municipal bond markets
performance this year. But the concern here at TMR is that beneath the calm on the surface of
the markets, potentially trouble trends are evolving.
Here at TMR we have been focusing on the potential threats to the trend that has characterised
the last several years of generally improving credit fundamentals for municipal bond issuers. In
particular, some long term trends could combine with near term event risks to create headwinds
for the continued improvement in municipal credit. Among the events and trends we will be
watching over the summer:
z According to a recent report by State Budget Solutions, federal aid accounted for over over one-
third of state revenue in 24 states for 2012, compared to only 11 states in 2001. Most of the the federal
aid goes to public welfare programs, of which Medicaid is by far the largest. Other signifcant catego-
ries of federal aid to states are education, transportation and housing. The growing reliance on the
federal governments dysfunctional budget process creates ever greater uncertainties for state and
local budgets.
z The implications of of this reliance on federal funds are being made clear in Virginias (Aaa/AAA/
AAA) troubled budgeting process this year, for example. A debate about expanding Medicaid under
the Affordable Care Act has prevented the state from dealing with lagging tax revenue and has so far
delayed prevented the state from adopting a FY15 budget, which is due by June 30.
z The failure to address the long term solvency of the Highway Trust Fund (HTF) is another key case in
point. By some reports the HTF could run out of money in July. Many states issue Grant Revenue An-
ticipation Revenue bonds (GARVEES) backed by expected future receipts of grants from the HTF, using
the proceeds to fund highway transportation infrastructure.
z On a different front, state and local governments are also likely to face continued pressures as
public unions push back after the last several years of having to accept austerity and budget discipline.
Challenges to pension reform measures in Illinois and Rhode Island threaten to derail reforms whose
passage played important roles in stabilizing at least the perception of credit trends in those states,
for example.
z Lastly, we would not be surprised to see renewed discussion of the possibility of debt restructurings
in Puerto Rico over the summer. Eventually many of the islands authorities, such as Puerto Rico Elec-
tric Authority (PREPA) will need to have their debt loads addressed. When PRs government takes that
step, market concerns are likely to resurface and shake investor complacency again.
The theme of this week's
MUNIVERSES is what we'll be wor-
rying about this summer.
Re-BABS?
z The federal government's
role in municipal fnance would
expand further under a proposal
by Senate Finance Committee
Chairman Ron Wyden (D-OR)
to resurrect the Build America
Bond program.
z The new program would be
called Rebuild America Bonds
z After issuer subsidy pay-
ments under the original BABs
program were interrupted by
sequestration, issuers may be
slow to embrace Re-BABS.
TRIDENT MUNICIPAL RESEARCH, LLC
A JOINT VENTURE OF ARBOR RESEARCH & TRADING, LLC & ALPRION CAPITAL MANAGEMENT LP
verse one
surveyi ng the hori zon
TRI DENT
MUNI CI PAL
RESEARCH
Municipal Market Weekly
Thursday, May 22, 2014
MUNIVERSES
Full Count and Still Swinging
The thing about annual appropriations is they that they happen every year. A year ago, Rhode
Island's legislative leaders were grappling with the question of whether or not honor moral obliga-
tion bonds after 38 Studios, a video game company which benefted from the proceeds of the bond
issue in question under the state's Job Creation Guaranty Program. 38 Studios, which counted
among its founders former major league baseball pitcher Curt Schilling, declared Chapter 7 bank-
ruptcy in 2012 and entered liquidation, leaving insuffcient assets to pay off the bonds. In the end,
RI legislators decided they didn't want to damage the state's credit position and appropriated the
necessary funds.
During last year's debate the rating agencies took a relatively sanguine view, noting that the risk of
non-payment was always remote, because Gov. Chafee and State Treasurer Gina Raimondo, widely
seen a leading contender in the upcoming gubernatorial elections, both supported honoring the
moral obligation.
Now, however, the appropriation for the moral obligation payment has surfaced as one of the major
issues in this year's budget negotiations and several gubernatorial candidates have voiced support
for not appropriating funds for the moral obligation bonds and allowing them to default. Rating
agency reception of this possibility was stronger this time around, with S&P in particular warning
of downgrades to all state level credits, including the general obligation if the moral obligation is
allowed to default.
To review, the form the moral obligation takes is as follows. Rhode Island Economic Development
Corp (RIEDC) was authorized to issue the bonds under the Job Creation Guaranty Program and lend
the proceeds to 38 Studios. The bonds clearly state that they do not constitute a debt, liability or
obligation of the state, but, keep reading, are "payable solely from, and secured by, among other
things, Loan Payments by the Company...amounts on deposit in certain funds...and certain appro-
priations made by the State." In particular, if suffcient funds are available in the Capital Reserve
Fund, then RIEDC is required to make a requisite to the legislature to appropriate funds. While not
an explicit and unconditional guaranty, we do view this as a commitment by the state to step in if
possible.
Rating agencies face a delicate balance in such situations, taking a preemptive downgrade action
before a non-appropriation event actually occurs can have potentially unwarranted market fallout.
Investors, however, would be fully justifed in adopting a "show me" attitude toward RI debt, espe-
cially bonds involving appropriations.
Last year we cautioned that a
failure to honor the moral obli-
gation would have consequenc-
es beyond this one failed, and
obviously fawed, fnancing.
z See "Swing and a Miss!",
MuniVerses Verse Two, June 6,
2013.
z The affair has since grown to
include possible lobbying inpro-
prieties and has seen the state's
House Speaker relinquish that
role.
z The question of allowing a
default has also become a major
issue in gubernatorial elections
Rating agencies, the bond
insurer and investors all clearly
considered the state's moral
obligation as a factor when
evaluating the bonds.
z As we noted in last year's
piece, there is precedent for RI
appropriating to support moral
obligation debt.
z It is interesting to note that
after last year's debate, the
legislature revoked RIEDC's
ability to issue such moral
obligation guarantees.
TRIDENT MUNICIPAL RESEARCH, LLC
A JOINT VENTURE OF ARBOR RESEARCH & TRADING, LLC & ALPRION CAPITAL MANAGEMENT LP
verse two
followi ng the currents
TRI DENT
MUNI CI PAL
RESEARCH
Municipal Market Weekly
Thursday, May 22, 2014
MUNIVERSES
verse three
charti ng the course
As Good as It Gets?
State and local governments suffered a real and signifcant credit shock during the fnancial crisis
and ensuing Great Recession. During much of the period from 2009 to 2013, municipal bond inves-
tors enjoyed the dual benefts of improving credit fundamentals and declining interest rates. That
combination produced positive absolute performance and relative outperformance.
By contrast, the sell off during 2013's "taper tantrum" was mainly about investor psychology. Selling
pressure on fund vehicles, spurred by the fact that funds had broad exposure to deteriorating Puerto
Rico credits, exacerbated the general negative tone created by increasing rates. 2014 has seen
those pressures ease and therefore has delivered outperformance. The outperformance has been
aided by 1) lack of supply, 2) lack of volatility, and 3) lack of signifcant new credit headlines. It is
understandable that the absence of these catalysts could instill a sense of complacency, as we dis-
cussed in VERSE ONE.
Investors should keep an eye on both demand metrics and supply pressure and be prepared to
reduce exposure to municipals if and when those factors turn negative.
Thesis: Despite the unevent-
ful market implied by 1) lack of
supply, 2) lack of volatility, and
3) lack of signifcant new credit
headlines.
Changes in any of these
factors would be negative for
municipals.
Confdence: Medium
Concerns: The timing of when
investor complacency is shaken
is highly uncertain and depen-
dent on an outside catalyst.
source: Bloomberg
TRIDENT MUNICIPAL RESEARCH, LLC
A JOINT VENTURE OF ARBOR RESEARCH & TRADING, LLC & ALPRION CAPITAL MANAGEMENT LP
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
5/21/2013 8/21/2013 11/21/2013 2/21/2014 5/21/2014
Premium / Discount % NAV
Municipal ETFs
PRM/DSC PRM/DSC ex HYD
0
5,000
10,000
15,000
20,000
5/21/13 8/21/13 11/21/13 2/21/14 5/21/14
30-Day Visible Supply
($ millions)
Visible Supply
About TMR
Trident Municipal Research, LLC ("TMR") is a joint venture of Arbor Research & Trading, Inc and Alprion Capital
Management LP focused on providing high-quality, independent research for the municipal bond market.
Arbor Research & Trading, LLC (Arbor) is an institutional research and brokerage firm that produces innovative
research across a broad range of global fixed-income, equity, currency, and commodity markets. In addition, Arbor's
trading desk provides comprehensive issue discovery and high quality execution in the fixed income and currency
markets. Unencumbered by the biases of holding positions or underwriting securities, Arbor offers objective viewpoints
and intelligent solutions for portfolio managers and traders world-wide through a proprietary menu of independent and
innovative research products designed to work in conjunction with clients and their systems. Founded in 1988,
Arbor has a long history of delivering innovative, technology-based products to many of the largest and most influential
financial institutions world-wide. As the landscape of global financial markets has changed, Arbor has adhered to its mission,
providing clients with timely analysis, objective opinion and first- class execution.
Alprion Capital Management LP (Alprion) is a New York-based investment manager focused on the municipal sector. Alprion was
founded in 2010 by a team of fxed income professionals with backgrounds in municipal credit and fundamental credit analysis.
DISCLAIMER
This communication is for informational purposes only. This is not an offer or a solicitation of an offer to buy or sell
any instrument or security. This document contains certain forward-looking statements and projections. Such state-
ments and projections are subject to a number of assumptions, risks and uncertainties which may cause actual results,
performance or achievements to be materially different from future results, performance or achievements expressed or
implied by these forward-looking statements and projections. Prospective investors are cautioned not to invest based on
these forward-looking statements and projections. Certain information contained herein has been supplied to Arbor and
Alprion by third parties. While Arbor and Alprion believe such sources are reliable, it cannot guarantee the accuracy of
any such information and does not represent that such information is accurate or complete.
THIS DOCUMENT IS NOT AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY INTERESTS IN A FUND MANAGED BY ALPRION CAPITAL
MANAGEMENT LP OR RELATED ENTITIES. AN OFFERING OF INTERESTS WILL BE MADE ONLY BY MEANS OF A CONFIDENTIAL PRIVATE PLACEMENT
MEMORANDUM AND ONLY TO QUALIFIED INVESTORS IN JURISDICTIONS WHERE PERMITTED BY LAW.
THIS MATERIAL IS FOR YOUR PRIVATE INFORMATION, AND WE ARE NOT SOLICITING ANY ACTION BASED UPON IT. THIS MATERIAL SHOULD NOT
BE REDISTRIBUTED OR REPLICATED IN ANY FORM WITHOUT PRIOR CONSENT OF TRIDENT MUNICIPAL RESEARCH. THE MATERIAL IS BASED UPON
INFORMATION THAT WE CONSIDER RELIABLE, BUT WE DO NOT REPRESENT THAT IT IS ACCURATE OR COMPLETE, AND IT SHOULD NOT BE RELIED
UPON AS SUCH.
Contributors
Bart Mosley, Co-President
Rob Novembre, Co-President
Jason Hannon, Capital Markets Team
Ken Kollar, Capital Markets Team
Steven D Schrager, Credit Consultant
We, the Contributors, hereby certify that all
of the views expressed in this report accu-
rately reflect our personal views about any
and all of the subject sectors, industries, se-
curities, and issuers. No part of our compen-
sation was, is, or will be, directly or indirect-
ly, related to the specific recommendations
or views expressed in this research report.
Sales & Inquiries
Max R. Konzelman
Vice President
Arbor Research & Trading, LLC.
max.konzelman@arborresearch.com
www.tridentmunicipal.com
TRIDENT MUNICIPAL RESEARCH, LLC
A JOINT VENTURE OF ARBOR RESEARCH & TRADING, LLC & ALPRION CAPITAL MANAGEMENT LP
TRI DENT
MUNI CI PAL
RESEARCH
Municipal Market Weekly
Thursday, May 22, 2014
MUNIVERSES
verse three
charti ng the course