Municipals: Focus on Revenue Bonds

Monitoring credit implications of macro and micro factors.

May 18, 2017


This Municipals sector report is excerpted from the Second Quarter 2017 Fixed-Income Outlook.

Since the presidential election, the municipal bond market’s attention has been split between high-profile troubled issuers and the policy focus du jour of the Trump administration and Congress. Away from the ongoing headlines involving developments in Puerto Rico, Illinois, Chicago, tax reform, and healthcare reform, we are focusing in on macro and micro factors that may have long-term municipal credit implications. For example, the ongoing rise in home prices, which have surpassed the previous high from 2006, bolsters local governments’ credit quality given that property taxes account for almost half of their revenues, or more than one-third when combined with state revenues (see chart, top right). On the other hand, we are still concerned about the fundamentals in state and local governments, where the gap between assets and liabilities continues to grow. State and local government defined-benefit pension plans have been underfunded consistently since 2002.

Property Taxes Drive State and Local Tax Revenues

Trends in home prices, which have surpassed the previous high from 2006, bolster local governments’ credit quality given that property taxes account for almost half of their revenues, or more than one-third when combined with state revenues.

Property Taxes Drive State and Local Tax Revenues

Source: U.S. Census Bureau, Guggenheim Investments. Data as of 3.31.2017.

Tax-exempt ratios and taxable credit spreads were largely unchanged over the first quarter despite elevated uncertainty. Municipal bonds posted a 1.6 percent gain in the quarter, with lower quality bonds outperforming. BBB-rated municipal bonds returned 2.2 percent, versus returns of 1.7, 1.5, and 1.4 percent for A-rated, AA-rated, and AAA-rated bonds, respectively.

Our strategic focus continues to be on dedicated revenue bonds characterized by high essentiality, as well as general obligation issuers with less vulnerability to structural pension issues and federal government policies. We believe value, or lack thereof, in our space resides in the minutiae and overlooked details that can uncover true credit risk. The March bankruptcy of Westinghouse Electric Co., which affects approximately $10 billion of municipal debt of Georgia and South Carolina issuers, emphasizes the scrutiny necessary for all underlying contractual and legal nuances. The bankruptcy also highlighted added layers of risk for greenfield project financings that will be increasingly relevant for infrastructure investments funded by the municipal market.

State and Local Defined-Benefit Pension Plans Are Increasingly Underfunded

The gap between assets and liabilities of state and local defined-benefit pension plans continues to grow. Plans have been underfunded consistently since 2002.

State and Local Defined-Benefit Pension Plans Are Increasingly Underfunded

Source: Federal Reserve, Guggenheim Investments. Data as of 12.31.2016.

—James Pass, Senior Managing Director; Allen Li, CFA, Managing Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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