Pennsylvania Woes Don't Crimp Trading

Some retail investors are being more cautious when shopping for tax-exempt bonds in Pennsylvania — where the number of distressed municipalities is growing — but overall, that hasn’t decreased the volume of trading in the state, according to local traders and underwriters.

“I think people are cautious of some cities, but no more cautious than they would be for similarly rated bonds,” said Alan Schankel, managing director of municipal research and strategy at Janney Montgomery Scott in Philadelphia.

Altoona is the latest city to be designated as fiscally “distressed” under the provisions of Pennsylvania’s Municipalities Financial Recovery Act, known as Act 47, from which only six have recovered since its inception in 1987, according to the Department of Community and Economic Development.

The act empowers the DCED to declare certain municipalities as financially distressed. It triggers procedures, guidelines and powers that help financially distressed governments provide vital services, meet debt and other financial obligations, and implement improved accounting, budgeting and taxing practices.

State oversight emphasizes long-term fiscal management improvements, service delivery efficiencies, intergovernmental cooperation, and economic and community development priorities.

On May 4, Altoona became the 27th municipality to be entered into the act. It was declared distressed because of its ongoing deficit, growing expenditures, and having reached its legal limit in levying real estate taxes for general purposes, according to DCED data.

Altoona has operated with a deficit in each of the last four years, with deficits ranging from 11% to as much as 19% of revenues for all governmental funds.

Schankel called Altoona and other distressed municipalities under the act, such as Allentown and Scranton, “typical Northeast cities that have lost population and are reinventing themselves.”

He noted that even though the list of distressed Pennsylvania municipalities has grown, that has not deterred bonds in the state from trading on par with the overall market.

Schankel added that Pennsylvania’s few triple-A credits, such as Lower Merion Township, are trading five to 10 basis points cheaper than Municipal Market Data’s triple-a yield curve.

Overall, investors are not panicking about Altoona or other distressed credits, but instead are taking the situation in stride.

“Every once in a while someone will put a bond out for a bid, and do a little price checking, but then hold onto it,” Schankel said.

On Tuesday, a $20,000 block of insured Altoona GOs with a 3.40% coupon due in 2016, callable at par in 2013, and an underlying rating of single-A from Standard & Poor’s, traded to a customer at $103.05 with a 1% yield, according to the Securities Industry and Financial Markets Association’s website, investinginbonds.com.

According to MMD, on Wednesday the generic, insured triple-A GO bond due in 2016 yielded a 1.07%.

Besides Altoona, Harrisburg — the state capital that was declared distressed in October 2010 — is trying to rectify its troubled finances.

It is immersed in $310 million of incinerator-related bond debt and endless political infighting, and it missed two general obligation bond payments in March totaling $5.3 million.

Retired Air Force Major General William Lynch — who helped rebuild Iraq — was nominated last Friday by Gov. Tom Corbett to succeed David Unkovic as the receiver for Harrisburg, where Mayor Linda Thomson and the City Council have battled over the financial recovery.

In October 2011 Corbett declared the capital in a “fiscal emergency” and the state later took over the capital after the City Council three times rejected a recovery plan under Act 47.

While other cities, like Scranton, struggle due to a tough economy and high unemployment, Schankel said the financial turmoil of the municipalities hasn’t had a significant impact on trading levels. “I don’t see anyone falling off a cliff,” he said.

“People are staying away from credits with low ratings, but those with good stories are doing fine,” a Pennsylvania underwriter said Tuesday. “General obligation and essential-purpose bonds are holding up well. Pennsylvania has tons of issuers, so 27 out of all the issuers is not a big number.”

Meanwhile, Schankel said when Harrisburg was first deemed distressed nearly two years ago, there was some immediate selling by retail investors, but nothing substantial. On the buy side, he said, cautious investors are opting for higher-quality credits, like Montgomery County, Bucks County and Delaware County, which are seeing solid demand in the secondary market.

Other investors with a little more appetite for risk are targeting higher-yielding paper, according to Schankel. For instance, many of the distressed credits were wrapped with insurance over the years, so they present less risk than the uninsured paper, he noted.

Dave Manges, first vice president of municipal trading at BNY Mellon Capital Markets in Pittsburgh, said while some Pennsylvania bonds, such as Pittsburgh, may trade at slightly tighter spreads than a few years ago, overall the market has not created any stigma surrounding those municipalities that are granted Act 47 status.

“I don’t look at it as a bad thing, I look at it as a good thing,” Manges explained. He said distressed Pennsylvania cities, such as Reading, mirror the fiscal struggles and poor demographics being felt around the state.

“The cities in Pennsylvania have issues and many of these smaller towns are having trouble recovering,” he said. “Putting a bandage on a long-standing problem is not the solution. Arguably, accepting Act 47 status is the solution that will lead to better trading performance of its debt in the future as opposed to weaker performance.”

Manges said he has not recently seen a flurry of distressed bonds in the secondary market, even as Altoona was added to the distress list, largely because most of them have been under pressure for some time and investors had previously sold out of any risky positions.

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