February 17, 2009
You can ignore the media hype that state issuers may default on municipal bond obligations and that these bonds are at risk of downgrades. “It is virtually impossible for a state to default on its municipal bond obligations,” says Tom Doe, founder and CEO of Municipal Market Advisors.
Doe’s firm provides independent research and strategy consulting to a diverse client base of more than 200 dealers, investors, high net worth individuals and issuers engaged in the tax-exempt market. He is a frequent speaker at industry events and recently completed a three-year term on the Municipal Securities Rulemaking Board (MSRB), the municipal securities industry’s regulatory entity.
We spoke with Doe on February 9 at his firm’s Concord, MA offices.
General obligation (GO) bonds and essential service bonds (e.g., water and sewer) dominate the muni market, accounting for approximately 70% of issuance. According to Doe, these bonds are well-protected by tax revenue. “Politicians can raise taxes and fees to provide these services and service their debt — even though it would be politically unfavorable — and the taxpayers understand this,” says Doe.
Doe warns his clients to be highly skeptical of historical muni default statistics. “Any default study going back more than 20 years cannot be apples-to-apples,” explains Doe, because revenue bonds did not emerge until the 1970s. “You cannot extrapolate muni default rates from the Great Depression to today,” he said.
Investors seem to be hearing that message. Over the last eight weeks, demand for individual GO bonds has surged, and prices have risen. Since early December, yields on these bonds have generally dropped 100 basis points, from 4.30% to 3.30% with some specific high-quality GO state issues rallying 150 basis points.
“Investors should feel very comfortable with muni bonds, except for those rated below single-A or project-specific bonds backing shaky areas like health care,” Doe says. Health care is among those areas most vulnerable to the weak economy and susceptible to a reduction in aid, according to Doe.
Doe also recommends investors be wary of the high-yield muni market, even though it was the strongest performing municipal sector in 2009, up nearly 8%. Some of those funds, like Oppenheimer’s Rochester National Muni Bond Fund, lost nearly half their value in 2008. Doe says Rochester is among those now reconstituting their portfolio with higher-quality names.Display article as PDF for printing.
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