The state of Muni’s matters to a lot of investors. I have argued in Investing in Munis that the States will be loathe to damage their ability to go to the Muni market, so will cut everything else they can first before defaulting or delaying payment. That argument passed its first test in the last few days.
July starts a new fiscal year for most State governments, and some of them (Ill, Cal, NY) are in dire straits with huge deficits, ebbing Federal stimulus, and disappointing tax revenues. Bloomberg reports that they are cutting pay and letting bills go unpaid to protect their Munis:
“States have taken all measures so far to make sure they keep capital markets open by honoring their debt payments,” said Richard Ciccarone, a managing director for McDonnell Investment Management LLC in Oak Brook, Illinois, which owns $7 billion of municipal bonds. “They are doing everything they can.”
The story repeats the comforting history of Muni defaults: at 0.03%, much less than similar corporate bonds at 0.97%. Most Muni defaults have not been general obligation bonds, but bonds tied to specific projects. Hence investors in Munis need to read through to the party really at risk; a special industrial district, hospital or similar project is much riskier than the State itself.
The CDS spread between Munis and similar corporate bonds has been higher for Munis, which might seem odd given the default history above, but it reflects the differing positions: US corporations are sitting on record cash, and their bonds are one of the safe harbors right now, while States are in deep deficit for the most part. The good news for Munis is the spread is narrowing as the fears of Muni default begin to ebb.
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