Is the municipal bond glass half empty or half full? Lately, it looks half empty.
Financial advisors are keenly aware that the muni-bond market today is in sad shape. How sad is open to dispute. The Center on Budget and Policy Priorities, a Washington, D.C., nonpartisan research institute, was projecting state budget deficits of $200 billion for 2010.
However, it estimates those state budgets deficits should shrink to $180 billion and $120 billion in 2011 and 2012, respectively. As of October 2010, that year's $1.6 billion in defaults in municipal securities represented a decline from $8 billion in 2008 and $7 billion in 2009, according to the Distressed Debt Securities Newsletter, Seattle. But that newsletter expects defaults to rise in 2011 because Uncle Sam's economic assistance may decline, and state budget problems could hinder debt payments.
Meanwhile, states also face unfunded pension liabilities of $1 trillion, according to the Washington, D.C.-based Pew Research Center. The state of Illinois staved off a potential default by issuing $1.5 billion in tobacco bonds in December 2010. The proceeds were expected to let that state pay its bills. Meanwhile, cash-strapped California issued $3.3 billion in bonds to beef up that state's coffers.
With all the bad news, it's becoming tough for financial advisors seeking a safe haven for conservative clients to turn to individually insured municipal bonds or bond funds. Adding to their difficulty is the disappearance of bond insurers after the 2008 financial collapse. The Hamilton, Bermuda-based Assured Guarantee Ltd. is the only company insuring bonds, according to The Wall Street Journal. And there no longer are any municipal bond funds that carry an average top AAA credit rating because of all the credit downgrades, according to a report by the Aite Group, a Boston-based research and advisory firm.
There also are concerns that since Standard & Poor's, Moody's and Fitch recalibrated their muni-bond ratings to be more comparable with corporate bond ratings, many municipal issues have been upgraded.
Municipal revenue growth could be hindered for several years, according to a November 2010 survey by RBC Capital Markets in New York, the investment bank affiliate of Royal Bank of Canada. More than half of industry professionals surveyed say it could take at least five years before state and local government revenues return to pre-crisis levels. Driving concerns is the anticipated decline in the level of federal assistance for state and local governments over the next three years.
"While state and local governments have seen steep declines in revenues, the risk of defaults on bonds issued by these municipalities generally remains well below similarly rated corporate debt," says Chris Mauro, director of municipal bond research at RBC Capital. "Despite the fact that municipal credit quality has deteriorated in this recession, the public perception that municipal bonds have become a riskier asset class relative to corporate debt is simply not true."
It could take a long time, however, before economic conditions improve. State tax revenues are down 12% since 2008. In 2010, 46 states struggled to balance fiscal year budgets, reports the Center on Budget and Policy Priorities.
Adding fuel to the fire were concerns about the accuracy of the bond rating agencies' municipal bond ratings. At a hearing in New York last month, state insurance regulators were concerned about how much the bond ratings reflect current financial data, government pensions and health-care liabilities. Many states are notoriously slow to complete annual financial audits.