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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. 

 

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Please note that MUNI NATIONs that are written by Jim Colby represent his opinions and these opinions may change at any time and from time to time. MUNI NATION is not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. © 2014 Van Eck Securities Corporation. MUNI NATION is a trademark of Van Eck Associates Corporation.

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Any discussion of specific securities mentioned in the commentary is neither an offer to sell nor a solicitation to buy these securities.

Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.

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