I have a sneaking suspicion that Governor McDonnell will announce tonight the completion of the VPA lease of the Norfolk APM terminal. This is a great deal for both APM and the Port of Virginia. You heard it here first…

Yesterday, the Motley Fool website ran an interesting article by Nick Kapur titled “Why do we still listen to the ratings agencies“.  The general premise of the article is that the ratings agencies are either unable or unwilling to provide an accurate assessment of a company’s financial strength.  The author goes on to contemplate what role the ratings agencies played in the recent financial meltdown and how much responsibility we should assign them.

“The line here between ignorance and dutiful compliance is thin and not meaningful. Though many have alleged that the ratings agencies were on the take outright, it doesn’t really matter if they were or weren’t. Essentially, the ratings agencies were either crooked or they were stupid. Either way, they’re guilty.”

The article raises an interesting question of what role should a Moody’s or S&P rating play in an investors analysis?  Should they still be trusted, or have they lost all investor confidence?  Finally, is there an opportunity for a new player to emerge as a truly unbiased opinion, and what would that new player have to do to earn the respect of the investing community?

I believe there is an opportunity, but the road to respect will be a long one.  Thorough, independent analysis will always be worth much more than a 3rd party report from a vendor whose motivations may be cloudy at best.

Yesterday, Governor Bob McDonnell had the pleasure of being able to announce that the Commonwealth of Virginia had been awarded Site Selection magazine’s 2010 Competitiveness Award.  Since its inception in 2003, the award is given annually to a state that excels in 10 criteria related to its ability to attract new companies, facilities and jobs.  2009 was an extremely difficult year for many businesses and Virginia’s ability to attract new business is a testament to the hard work and dedication of the Virginia Economic Development Partnership.  VEDP does an exceptional job of growing and enhancing Virginia’s economic base and this award is a great start towards getting them the recognition they deserve.

Shortly after President Obama signed the healthcare reform legislation into law, several states have filed lawsuits because the new Medicaid requirements will potentially bust their budgets.  So, what does this have to do with Infrastructure?

To begin with, anything that strains the state or municipal budget will limit their ability to fund new projects.  That’s not good news.  But, there is another tie in here that will severely limit localities access to capital.

As I mentioned a few days ago, Florida suspended its issuance of Build America Bonds (BAB) because of the potential that the IRS would reduce their subsidy amount by any amounts owned from other programs.  The new healthcare reform will significantly increase the costs to the states for Medicaid expenses.  If they are unable to cover the increased costs, the IRS will start taking from their BAB subsidy to get whole.  That puts even more pressure on the states and compounds the issue.  Florida estimates that the new healthcare reform law will add $1.6 billion of Medicaid expenses and force them to hire an additional 1,000 employees.  That’s $1.6 billion that they won’t have available to build schools, maintain roads, or repay bonds.

In a time when the states and municipalities are being hit financially as hard as ever, I struggle to understand the rational behind increasing the burden on them.  Maybe someone can explain it to me…

Bloomberg ran an article (see link here) this week about how the state of Florida has temporarily suspended the issuance of Build America Bonds due to a potential glitch in the refunding mechanism.  For those that aren’t as fmailiar with the Build America Bonds, or BABs as they are known, they are a product of the ARRA Stimulus legislation and represent the fastest growing segment of the $2.8 trillion municipal debt market.  The BABs are unique in that they are issued as taxable bonds with taxable equivalent yields, yet the issuing locality receives a refund from the IRS equal to 35% of the interest costs.  This, effectively, makes the cost to the issuer on par with tax free options.

Florida, however, has some concerns about how that 35% subsidy will be paid and has put its $255 million upcoming issuance on hold.  In a recent call with the Internal Revenue Service, the IRS reiterated that any subsidy due to the locality will be reduced by any amount that the issuer owes the federal government for other programs, including Medicare.  This is not a new provision of the BABs and has been a condition since their inception.  However, many of the localities are just now catching on to the fact that they may not get the full subsidy they have been expecting.

This becomes especially relevant as Congress seeks to pass the Healthcare Reform that could dramatically increase an issuers payments to the federal government for Medicare and similar type programs.  Should an issuer not be able to make its Medicare payments, the IRS will still get “theirs” through the BAB subsidy, leaving the locality in a death spiral of interest obligations.

According to the article, the largest issuer of BABs, California, is aware of the IRS claw-back provision and is continue to utilize BABs as a viable funding source.  It will be very interesting to see how many other states join Florida in taking a wait and see attitude.

In a brief news article, tucked neatly towards the bottom was one sentence with incredible global implications:

“The big drop in China’s holdings meant that it lost the top spot in terms of foreign ownership of U.S. Treasuries, dropping to second place behind Japan”

Chin ahas long been the largest holder of US Treasuries.  They are (were) our go-to group when we (the US) needed to raise some cash.  If the demand for our Treasuries from China drops off, that could lead to the US paying higher interest rates and a double dip recession for our economy.

It now appears that they are in fact reducing their holdings.  In fact, China has been reducing its exposure to US Treasuries for some time now.  While they are not out in the market selling them (that we know), they are trending towards purchasing shorter  duration notes.  This gives them a quicker “out” when the time comes.

When will that time be?  Well, that’s the $64,000 question.  If they were to dump their holdings onto the market at once, they would devalue the holdings they are trying to sell and do more harm to themselves than they care to.  If they become gradual sellers, they would damage the US economy and potentially we would not be able to buy as many Chinese made goods – again hurting their economy.

What China is doing is making every effort to create a burgeoning middle class that can replace the US as the consumer of their manufactured goods.  With 2 billion people to work with, that shouldn’t take too long to replace the 300 million or so US consumers.  Once that middle class is in place, China has much more freedom in their financial policy because they are not as tied to the US consumer.

This is one that will definitely take some time to play out, but it will play out and it will have dramatic consequences for our economy.

It seems like the worst may yet be over.  The Congressional Oversight Panel recently released its February Oversight Report entitled, “Commercial Real Estate Losses and the Risk to Financial Stability”.  You can read the full report HERE.  While the initial wave of destabilization came from the larger institutions (think AIG, Lehman Brothers, Etc.), this looming round could come from the nations’ small to mid-sized banks.

The report estimates that in the next 4 years over $1.4 trillion (with a “T”) of commercial loans will come due and need to be retired or refinanced.  In one half of those cases, the value of the underlying asset is now worth less than the amount owed on the loan.  They are “underwater” and they are a problem.  Losses to the lending institutions could total over $300 billion.  That’s not the amount that will default.  That’s the loss realized after foreclosing on the property, finding a buyer and selling it for whatever can be achieved.

But wait, we ran the Stress Test and our banks have the capital reserves to weather this storm.  Unfortunately, the Stress Test only looked through 2010.  The vast majority of these loans will become a problem for the banks in 2011-2014.  Plus, the Stress Test was only run on the larger banks.  The small and mid-sized banks were never subjected to the Stress Test.

On the plus side, there has been an insane amount of equity raised to acquire these troubled assets.  Once the banks have foreclosed on the assets and they are brought to market, there should be a willing pool of buyers.  The question then becomes, will there be so many buyers that the value get bid up to a point where the “distressed buyers” are no longer interested.  My best guess is that you see an initial round of sales at very attractive pricing.  As buyers flock to this sector, the demand and valuations will go up and the transaction volume will go down.

The worst may not be over yet for the US Municipal Bond market.  That’s according to a recent report from the ratings agency Moody’s Investors Service.  The report shows that in 2009, the agency downgraded 279 state and local government tax-backed bonds.  That is up 244% from 2008 when Moody’s downgraded only 81 such entities.  Overall, the ratings fell for 300 revenue debt issuers, up from 133 in 2008.

While the struggles that state and local governments are facing to balance their budgets is nothing new, we are beginning to see the hardship take a toll on their credit ratings.  Those lower credit ratings will make it much more difficult and costly to issue bonds, exacerbating the problems they are facing.

Econstories.tv has posted a very entertaining video comparing the economic theories of John Maynard Keynes and the free market theorist Friedrick von Hayak.  It’s a little long at over 7 minutes, but well worth investing the time.

So, who do you side with?  Keynes or Hayak?

I recently came across this bleak outlook for the US Municipal Bond Market written by Frederick J. Sheehan (see link below).  While this is just one man’s opinion, it’s enough to give a bond investor at least a few sleepless nights.  Some of the historical precedents he points out, especially those from the Depression Era, are chilling.

The Coming Collapse of the Municipal Bond Market (PDF)

It should come as no surprise that analyzing and quantifying “risk” are the name of the game in this economy.  The risk profile for Municipal Bonds is no exception.  Unfortunately, there may be some validity to the concept that Municipal Bonds carry more risk than anyone had anticipated.