U.S. Downgrade Domino Threat
– August 2011
The prevailing August municipal bond market story was
the threat posed by the U.S. rating downgrade. The improving
state tax situation and the search for better yields also
led municipal bond market news in the past month.
Wholesale municipal rating downgrades unlikely
As we wrote in our market update The
Effect of a U.S. Rating Downgrade, the downgrade did
not surprise us. Internally, we have discussed a possible
downgrade of the U.S. and its impact on other rated municipal
issuers for some time. The downgrade of the U.S. was unprecedented
and as such it is impossible to predict any outcome. However,
in the near term, we do not believe there will be wholesale
rating downgrades of municipal issuers excepting those
issues either directly secured by U.S. Treasury issues
(pre-refunded and escrowed to maturity issues) or indirectly
secured by government agencies (such as certain housing
and student loan issues).
This latest development leads to a glaring question. How
do market participants interpret credit ratings? Therein
lies the bottom line we have believed for a long time
– at the outer edges, municipal bond credit analysis
is as much an art as it is a science. Independent municipal
bond credit research
matters now more than ever.
State revenues improve for sixth quarter, fastest
growth in six years
State revenue collection continued to improve in the second
quarter of 2011 and boosted balance sheets. The
Rockefeller Institute's report on preliminary data
from 46 early reporting states shows collections from
major sources up 11.4 percent in the second quarter vs.
the same quarter last year – the strongest year-over-year
growth since the second quarter of 2005. Tax collections
have now been growing for six consecutive quarters, reversing
the trend set by five quarters of declines. Revenues were
still 7.8 percent lower than in the same period three
years ago.
The strong, continued tax collection growth in 2011 for
every state except New Hampshire indicates that the revenue
situation is slowly recovering for most state governments.
Alaska, North Dakota, Illinois, Nebraska and New York
showed the greatest total tax growth – with Illinois
up 37.7 percent overall. Most states have closed their
books for fiscal year 2011 and preliminary data show 8.4
percent tax revenue growth for the nation as a whole.
Municipal bond fund outflows signal search for
better yields
A new round of outflows from municipal bond funds continued
through every week of August. Unlike the municipal bond
fund selloff of late 2010 driven largely by credit concerns,
this new trend appears to be motivated by investors in
search of better yields. As we mentioned in our Mid-Year
Municipal Credit Update and other publications, municipal
market yields are transitioning toward specific idiosyncratic
issuer credit risk and away from the very homogenous “AAA-insured”
interest rate sensitive environment.
While this may unnerve some municipal investors, it is
a development that ultimately will reward those that have
carefully followed our three
pillars of municipal credit research. Investors willing
to accept incrementally more credit risk will be compensated
with a boost in yield. Additionally, investors in longer
maturities will be rewarded for accepting the interest
rate risk.
Ronald P. Bernardi
President and CEO
Bernardi Securities, Inc.
September 7, 2011
For more information, please contact
your Investment Specialist.
RELATED TOPICS:
Municipal
Default & Disclosure, Credit
Research, Bond
Insurance & Ratings
Return
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This document has been
prepared by Bernardi Securities, Inc. (BSI) for our clients
and other interested parties. Within this document, we
may express opinions about the direction of financial
markets, investment sectors, trends, and taxes. These
opinions should not be considered predictions of future
results, and are subject to change at any time. Past performance
is not indicative of future returns. Nothing in this document
represents a recommendation of any particular strategy,
security or investment product. This information is provided
for educational purposes only and was obtained from sources
considered reliable, but is not guaranteed and not necessarily
complete. BSI offerings are made by prospectus or official
statement only. Income may be subject to state and local
taxes and the federal alternative minimum tax. Additional
risks associated with investing in municipal bonds include
credit risk, interest rate risk, and reinvestment risk.
Please consult your tax professional regarding the suitability
of tax-free investing. Please consult your investment
specialist for more information.
Municipal bonds
not FDIC insured * May lose principal * Not appropriate
for all investors
