It used to be said that only certain types of investments, including the bluest of blue chip stocks, Treasury securities, and municipal bonds, should be owned by those who, like widows and orphans, valued quality and safety above all else.
Given the way that things are going, however, it is getting much harder to make the case that any of those asset classes represents a truly conservative investment choice these days.
For the latest developments in the market for state and local government-issued debt, for example, check out the following Financial Times report, "Muni Bonds Feel US States’ Fiscal Stress":
California’s high-profile budget crisis and the fiscal woes of states throughout the US are taking their toll on the public finance markets, sending borrowing costs higher for states, cities, counties and other municipal issuers.
The Golden State and its gaping $24bn deficit have caught the headlines, but a handful of other states have also failed to agree on balanced budgets, even after federal stimulus. They include Pennsylvania, North Carolina, Arizona, Connecticut, Illinois and Ohio. Even the states that have passed budgets have been forced to make dramatic cuts such as closing schools and laying off staff to compensate for plunging tax receipts.
This is the first time in 20 or 25 years that we have seen a recession affect the entire nation simultaneously,” says Robert Kurtter, a managing director in the public finance group at Moody’s Investors Service. “Most have been regional or sectoral in nature, such as manufacturing recession in the Midwest or the tech bust in California.”
States, cities and other entities raise money in the $2,700bn municipal market for projects and services benefiting the public good. Interest income on the bonds is exempt from some US taxes.
Yields on California’s long-term muni bonds are hovering at 6.10-6.20 per cent, up from about 5.50 per cent a few months ago and a full percentage point more than most other states. However, they are off recent highs as opportunistic buyers have moved in.
But the uncertainty surrounding the California situation and the publicity that it has received is weighing on the overall market.
Even yields for top-rated, or triple A muni bonds, have increased slightly to 5.16 per cent from 5 per cent in the past few months. Matt Fabian, managing director at Municipal Market Advisors, a research company specialising in muni bonds, says yields should be lower, given a popular federal stimulus plan that subsidises state and other issuers to sell taxable munis, in effect drawing supply out of the tax-exempt muni market.
“People are worried about committing capital to munis right now in the face of potential credit problems and ratings downgrades resulting from the state budget issues,” he says.
By law, most US states have to enact balanced budgets. Otherwise, the financial workings of the government can go into a virtual shutdown, as has been the case in California. The state last week began issuing IOUs for payments including welfare checks and vendor bills. Arnold Schwarzenegger, state governor, has asked banks to accept the IOUs.
Even in the absence of a budget, most states have measures in place to prioritise debt service or ensure that it continues for general obligation bonds. GOs are backed by the full credit of the state.
In California, for instance, the only payments that the state makes ahead of the bonds are funds for education, such as paying school teachers.
Pennsylvania, another state without a balanced budget, has a state constitutional requirement that it maintain debt services on its GOs.
This system so far has helped to insulate the muni bond market, even as states faced cumulative budget gaps of about $120bn heading into June 30, which is the fiscal year end for 46 of the 50. Even with the lowest state credit rating, California still ranks in the single-A area.
Ratings agencies are not considering sweeping credit downgrades for states based on late budgets alone, but persistent fiscal stress may pressure credit quality.
“We don’t see late budgets by themselves causing downgrades, but the fiscal pressures faced by states across the country due to the weak economy could result in some downgrades,” Mr Kurtter said.
He also says that local entities such as counties and school districts will come under pressure after states reduced allotted spending to them to plug gaps.
Budget gaps could again open as the economic downturn continues.
“The muni credit cycle is not over yet,” says Gary Pollack, head of fixed-income research and trading in the private wealth management group at Deutsche Bank. “There is a risk that the second time around it is harder to close a budget after you have already made your cuts and received bail-out money from the federal government.”
California State taxable GO's posting: 7.50% due 2034 traded this morning at about 8.2% yield to maturity. For more details see: http://california.municipalbonds.com/bonds/recent/page:2/sort:security_description/direction:asc
Considering that the typical stock mutual fund has barely broken even over the past 10 years, this might be a good trade for a pension fund with a long time horizon. Of course in a world of $200 a barrel oil and long Treasuries yielding 15%+, which we may see in a couple of years, the trade would look pretty bad. But then so would a lot of trades. You pay your money and you take your chances.
Posted by: Rocky | July 07, 2009 at 11:44 AM