The best-performing U.S. debt in 2014 is from municipalities, showing confidence in the fiscal stewardship of state and city leaders as they tackle challenges from crumbling roads to climbing pension deficits.
The $3.7 trillion market for local obligations has returned 9 percent this year through October, rallying for an unprecedented 10 straight months, according to Bank of America Merrill Lynch index data. That exceeds the 7 percent return for investment-grade corporate debt and the 4.8 percent gain for both high-yield company securities and Treasuries.
Even as Americans sour on their elected representatives in Washington, those with the most at stake in financial markets have signaled a growing appetite for tax-exempt bonds. Issuers from California to New York are winning stronger ratings for their fiscal prudence, more than five years after the end of the longest recession since the Great Depression. With bolstered budgets, they’re asking voters today to approve the most new debt since 2008 for delayed infrastructure repairs.
“An inherent strength of munis is that by and large they’re running balanced budgets every year, so they have to make the tough decisions around spending cuts or revenue increases,” said Chris Alwine, who oversees $140 billion as head of munis at Vanguard Group Inc. in Valley Forge, Pennsylvania. “They’re gradually returning to a growth mode.”
U.S. states faced a combined $191 billion of budget gaps in fiscal 2010, following the 18-month recession that ended in June 2009, according to data from the Henry J. Kaiser Family Foundation. The shortfalls led to predictions of widespread local-government defaults, culminating in banking analyst Meredith Whitney’s December 2010 forecast of “hundreds of billions of dollars” of failures within 12 months. The call, which failed to materialize, helped propel a then-record exodus from state and local debt.
As their budget gaps shrank 70 percent from 2010 to 2013, states have won lower borrowing costs. Benchmark 10-year munis yield 2.13 percent, about the lowest since May 2013, data compiled by Bloomberg show. The outperformance for state and city bonds has pushed yields on AAA rated munis to about 90 percent of those on similar-maturity Treasurys, compared with a five-year average of 98 percent. The lower the ratio, the costlier munis are to investors relative to federal debt.
No state has ascended as much since the recession with credit-rating companies as California. The most-populous U.S. state, which issued IOUs to pay creditors in 2009, had its grade raised in June by Moody’s Investors Service to Aa3, the fourth level of investment grade and the highest since 2001.
As recently as 2010, California was ranked three steps above junk by Moody’s. Now, with a projected surplus for the fiscal year that began July 1, voters have the chance today to approve a rainy-day fund that will put aside excess capital- gains tax revenue.
New York also earned upgrades from the three biggest credit raters this year after Democratic Governor Andrew Cuomo won a fourth consecutive on-time budget.
Across the U.S., Standard & Poor’s upgraded 1,255 public-finance issuers in the first half of 2014, while lowering ratings on 410. In 2011, S&P lifted ratings on 794 borrowers while cutting 585.
“In 2009, 2010 and 2011 we were all about cutting,” said Matt Dalton, chief executive officer of White Plains, New York- based Belle Haven Investments, which oversees $2.4 billion in munis. “Municipalities have gone from being in very serious shape to having more money than they know what to do with.”
Demand for munis and improving local government finances contrast with Americans’ view of the nation’s direction. About 21 percent of respondents in a Gallup poll conducted last month said they were satisfied with the way the country is going, the least since November 2013. A majority hasn’t approved of the nation’s direction since 2004.
Investors remain concerned that retirement obligations will strain municipal resources. Funding gaps for the largest U.S. public pensions tripled from 2004 to 2012 to $2 trillion, Moody’s said Sept. 25 in a report.
“That’s going to be the differentiator in credit,” Peter Hayes, who oversees $122 billion as head of munis at New York- based BlackRock Inc., said on “Bloomberg Surveillance” with Tom Keene and Michael McKee.
Localities are still gaining enough confidence in their fiscal prospects to ask taxpayers to allow bonding for infrastructure work. The U.S. needs an estimated $3.6 trillion of investment in infrastructure by 2020, according to the American Society of Civil Engineers.
Voters today are set to consider about $44 billion of bonds for schools, water systems and roads, more than twice what governments sought in 2010, according to Ipreo, a New York-based financial-market data provider.
Drought-plagued California is seeking $7.5 billion of borrowing for water supply infrastructure, and New York is asking to issue $2 billion for classroom technology equipment.
By contrast, in the five years from 2009 to 2013 states and cities asked for a combined $98 billion as tax revenue declined amid falling home values.
“We understood that during the recession, we couldn’t be going to the taxpayers and asking them for money,” said Benjamin Leong, chief financial officer of Broward County Public Schools, which is asking to issue $800 million of general obligations to finance projects. “But now after all these years, we need to go back and ask the community to invest into our schools.”
© Copyright 2024 Bloomberg News. All rights reserved.