The municipal CDS market has come into sharp focus in the past year with monoline troubles, spread widening, and the general negative economic outlook calling attention to credit risk.
This is despite historically low default rates, particularly for the investment grade segment.
Channeling the heightened industry attention into good use is Markit. The data firm announced the launch of the MCDX last week on a conference call.
The new product is a U.S. index that is made up of 50 CDS contracts, referencing the most liquid municipal issuers. The index is also the first credit index launch since Markit took control of the global credit and structured finance index suite in November 2007.
MCDX will leverage both the existing standardization in the municipal CDS market as well as what has been learned in other credit markets from launching their indices, a participant on the call said.
The product launch comes at an opportune time. While other industries have stalled in new issuance, because of an uncertain economic forecast, the new-issue supply in municipal bonds does not show signs of abating.
Contributing to this trend is the conversions of the much publicized auction rate securities market into longer-term debt, another call participant said.
Bankers are also pushing their issuers to take advantage of relatively low interest rates. "The bottom line is that we are likely to see continued heavy issuance of $375 billion or more annually for some time," the participant said. The amount of new issues that hit the market in 2007 reached $469 billion, according to data from the Securities Industry and Financial Markets Association, which was cited on the call.
The launch date for the new platform is May 6, and will be supported by bank dealers including Citigroup, Goldman Sachs, JPMorgan, Merrill Lynch, Morgan Stanley and UBS. Markit will manage the MCDX, publish daily closing prices, trading documentation and run auctions for credit events with Creditex, an e-trading platform that executes and processes credit derivatives.
The Depository Trust and Clearing Corp. will provide the platform for electronic trade confirmations. This is expected in late May, Markit noted.
Back to Basics
The index will comprise 50, unwrapped, equally weighted municipal reference credits. And it will trade with a fixed quarterly coupon. The decision to include 50 names in the index was a result of several factors including liquidity in the single name municipal CDS market, liquidity in the cash market, geographic diversification and rating diversification. "Fifty was the number that made the most sense as we started digging into the individual details of the credits that both fit into the criteria and reach that goal of creating a broad market tool for both hedging and directional views," one of the call participants said.
The constituents in the index are divided up among 24 revenue bonds (backed by revenue from a specific project), 21 state general obligation bonds and five local general obligation bonds (backed by the credit, and taxing ability of the reference entity).
Out of these bonds, 28% are rated triple-A, 60% are rated double-A, 8% are rated single-A and 4% are rated triple-B. Of the state general obligations bonds, the MCDX covers 75% of the new issue market.
The minimum rating for these obligations is Baa3' from Moody's Investors Service and BBB-' from Standard & Poor's and Fitch Ratings. The deals can also not be on a negative watch for downgrade to junk. The reference credits have at least $250 million in outstanding uninsured debt, as well. While the tenor for trades will be three years, five years and 10 years, liquidity is primarily focused in the 10-year single name CDS, a call participant said.
The new index will roll on Oct. 3 and April 3, when the names will be reviewed and replaced with a new reference batch.
Summary information and characteristics
Reference entities 50
Excludes Tobacco and Healthcare issues
Reference obligations Revenue, General Fund Obligation, Full Faith &
Credit
At least $250 million outstanding uninsured debt
Deliverable obligations Senior of equal or higher ranking in cap
structure
Ratings BBB- (S&P), Baa3 (Moody's), or BBB- (Fitch) or
and not on negative watch
Credit events Failure to pay
Restructuring
Coupon payment dates March 20, June 20, September 20, December 20
Roll dates April 3, October 3
Assumed Recovery 80%
rate for upfront calculation
Tenor 3, 5, 10 years
Settlement Physical
Auctions will be run in case of credit events
and cash
settlement will be hardwired in the future
Name MCDX.NA.10
RED ID 5A79DPAA5
Source: Markit
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