Municipal bonds thrive despite states' deep economic woes

Although state and local governments across the country face staggering budget deficits, their struggles are having little effect on municipal-bond prices.
JUL 19, 2009
Although state and local governments across the country face staggering budget deficits, their struggles are having little effect on municipal-bond prices. “Since the [second] quarter began, prices are definitely higher,” said Matt Fabian, managing director at Municipal Market Advisors of Concord, Mass. Average yield rates for 10-year, AAA-rated, general-obligation muni bonds were 3.28% as of July 16, compared with 3.44% during the previous week. Six months earlier, the average yields were 3.49%, according to Bloomberg LP of New York. Declining yields, which move inversely to price, indicate in-creasing demand for muni bonds. That is a somewhat surprising trend, given recent developments. Moody's Investors Service of New York lowered California's credit rating last week to Baa1, from A2, and said it could be lowered further if the state — facing an enormous budget deficit — doesn't soon get its fiscal house in order. “Moody's believes that as the days and weeks go by, without en-acted solutions to the current cash crisis and the $26 billion budget gap, the risk to priority payments, and eventually debt service payments, is increasing,” the ratings agency said in a statement.

ILLINOIS ON REVIEW

Moody's also put Illinois's general-obligation-bond ratings — currently A1 — on review for a possible downgrade, saying the state has long-term budgetary challenges. “The review will focus on consideration of the state's prospects for restoring structurally balanced financial operations, while addressing sizable funding requirements for pensions and retiree health benefits, as well as the state's liquidity position and growing debt burden,” the ratings update said. More state downgrades are likely, said Joshua Gonze, co-manager of muni portfolios at Thornburg Investment Management Inc. of Santa Fe, N.M., noting that New York, Arizona and Michigan appear to be in particular trouble. Louisiana is among the weakest states, fiscally, said Laura Porter, an analyst with Fitch Ratings of New York. Yet states place top priority on making their debt payments, and none is likely to default, she said. Even in California, which suffered a downgrade to BBB, from A-, from Fitch on July 6 and recently resorted to paying creditors with IOUs, default isn't imminent, said Douglas Offerman, an analyst with Fitch. California's constitution gives top priority to debt service, he said. That, however, doesn't mean that downgrades are meaningless. Bonds from states hit with downgrades will underperform, Mr. Gonze said. For example, last week, 10-year California general-obligation bonds were yielding just under 5%, according to Thomson Municipal Market Monitor, a unit of New York-based Thomson Reuters. That is an improvement from the end of last month, when the bonds yielded 5.2%, but it's a significant premium over the 3.28% average yield for 10-year, AAA-rated general-obligation bonds as of July 16. Some industry experts view California's troubles as a buying opportunity. New York-based BlackRock Inc. wrote last week in a note to clients that California bonds might be cheap enough for investors to jump in. “While it's too early to speculate as to whether we've seen the bottom, the assumption of a resolution and our belief in the state's long-term viability could translate into an opportunity to buy California munis at attractive levels,” BlackRock wrote the note. Some industry experts suspect that California bonds will see further weakness. “There's still a lot of negative news to come,” said Robert McIntosh, chief economist at Eaton Vance Corp. of Boston, who is waiting for prices to come down even further before he invests in California bonds. “I'm not convinced things are going to get better,” he said. “They're not going to default, but that doesn't mean they are a good value right now.” For good values, Mr. Gonze looks to revenue bonds from utilities and education agencies. Although general-obligation bonds from states with strong ratings may yield 10 to 20 basis points more than Treasuries, revenue bonds can yield more than 100 basis points above Treasuries, he said.

"CASH SUBSTITUTE'

For that reason, he thinks of general-obligation bonds as something of a “cash substitute,” Mr. Gonze said. Of course, how investors view muni bonds depends largely on the kind of investors they are, said Judy Wesalo Temel, director of credit research at Samson Capital Advisors LLC of New York, a fixed-income specialist. “For the clients we are working with ... this is their sleep-at-night money,” she said. As a result, Samson is on the lookout for the highest-quality issues, and those issues tend to be state general-obligation bonds, Ms. Temel said. Those bonds — along with muni bonds in general — should continue to perform well, she said. Bond buyers appear to agree. Cash flow into muni-bond mutual funds has remained relatively stable, according to the Investment Company Institute, the Washington-based trade organization for the mutual fund industry. For the one-week period ended July 8, muni-bond funds had estimated inflows of $1.04 billion, according to the ICI. Similar inflows were seen in the one-week periods ended July 1 ($1.31 billion), June 24 ($1.07 billion), June 17 ($1 billion), June 10 ($1.45 billion) and June 3 ($1.29 billion). Investor confidence in muni bonds reflects the fact that even during hard economic times, “the track record of muni bonds has been excellent,” said Jay Abrams, chief municipal credit analyst for FMSbonds Inc. of Boca Raton, Fla. E-mail David Hoffman at [email protected].

Latest News

'Bogged down' advisors just want to have fun (again)
'Bogged down' advisors just want to have fun (again)

Jim Cahn, of Wealth Enhancement Group, lifts the lid on his firm's partnership model, his views on RIA M&A, and the widely slept-on reason why advisors are merging into larger organizations.

Vestwell unveils new emergency savings account offering
Vestwell unveils new emergency savings account offering

The fintech firm is cementing its status in the workplace savings space with its latest ESA offering, which employers can integrate into their existing benefits package.

'Money Mimosas' and other ways to show your Valentine financial love
'Money Mimosas' and other ways to show your Valentine financial love

Wealth managers offer unique ideas for couples to grow closer emotionally and financially.

Limra research finds financial confidence on the rise among Black American workers
Limra research finds financial confidence on the rise among Black American workers

Survey findings suggest increased sense of financial security and more optimistic 2025 outlook, while highlighting employers' role in ensuring retirement readiness.

DOGE efforts sideswipe muni bonds backed by federal lease payments
DOGE efforts sideswipe muni bonds backed by federal lease payments

Falling prices for some securities within the $4 trillion state and local government debt market spotlight how the push to shrink spending is sending shockwaves across the US.

SPONSORED Record growth: Interval funds emerge as key players in alternative investments

Blue Vault Alts Summit highlights the role of liquidity-focused funds in reshaping advisor strategies

SPONSORED Taylor Matthews on what's behind Farther's rapid growth

From 'no clients' to reshaping wealth management, Farther blends tech and trust to deliver family-office experience at scale.