Credit Quality Update
- Thursday, 04/05/2012
- Challenges remain for some government issuers
- Valuation problems increase their interest cost
- My view: Defaults are not on the horizon
Governmental issuers of municipal bonds will continue under scrutiny as long as unemployment remains above 8% and the soft housing market continues. This focus is warranted due to concerns over muni bond price declines for issuers struggling with economic recovery.
Although overall municipal credit quality remains strong, muni issuers in selected areas continue to face budget pressures and revenue headwinds. When muni bonds drop in price, reflecting investor anxiety, the cost of government capital rises. For example, Rhode Island is an Aa2 and AA credit, but the state continues to lag in key recovery metrics. A downgrade to single A could mean an additional 30 to 40 bps in the state's interest cost.
Currently, only a few states are on negative credit watch. Moody's† has nine states, but S&P has just two and Fitch five. Conversely, S&P has three states on positive credit watch, Fitch two and Moody's none. California (A1, A-, A-) and Illinois (A2, A+, A) are the only states rated less than Aa quality, with Puerto Rico also in this category. Investors can take comfort in knowing that the great majority of state issuers are at least Aa and, in my opinion, they will continue to contribute positively to investment portfolios.
At the state level, we are far from the point where the word "default" belongs in intelligent discussion.
†Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s are third-party rating agencies that assess the credit quality of municipal and other bonds.