Brightening economic prospects and improving liquidity helped lift the municipal bond market in the third quarter in spite of numerous credit concerns and the evisceration of the bond insurance industry, according to the Securities Industry and Financial Markets Association’s quarterly report on municipal credit.
Competing undercurrents fought to determine the direction of the municipal bond market entering the second half of the year.
Working against the industry was the continuing deterioration in state and local budgets.
“The lengthy recession and high unemployment rate have led to diminished tax collections in virtually every state,” wrote Paul Rainy, the author of the SIFMA report.
Every state except Vermont reported shrinking tax receipts to the Census Bureau in the second quarter, which is the most recent data available. Federal stimulus funds were not enough to offset declining revenues, and states had to cut spending further, Rainy said.
Further, despite the apparent economic turnaround, the biggest factor contributing to the squeeze on local budgets — employment — “is projected to lag well into the future,” according to Rainy.
Moody’s Investors Service downgraded five municipal issuers for every four it upgraded in the third quarter. For every $1 in face value it upgraded, it downgraded $10.
This disparity was mainly attributable to the July 14 downgrade of California, which slashed the rating on $72 billion of general obligation debt.
In the industry’s favor was a rally in financial markets supported by the apparent emergence of the economy from recession.
The economy grew at 3.5% during the third quarter, according to the
Commerce Department.
Also bolstering the muni market was the Build America Bonds program, which enables issuers to sell taxable bonds and receive a subsidy from the Treasury.
Issuers have sold $51.8 billion of BABs so far, according to Thomson Reuters. In the third quarter they sold $20 billion, or 27.9% of total issuance, Rainy noted.
The economic recovery and the boost from federal programs overcame the credit concerns to bring yields to historically low rates.
Municipalities sold $91.7 billion of bonds in the third quarter, which is above the average for the previous five years.
