State Tax Growth Favors Munis, U.S. Trust Says

Municipal credit quality has improved, widespread defaults are unlikely, and the municipal bond market if rife with investment opportunities, thanks to fourth-quarter growth in state tax revenues, according to U.S. Trust, Bank of America, N.A.

The asset management firm said the 5.2% year-over-year growth reported by the Rockefeller Institute of Government “is a positive for overall municipal credit quality,” and is strong enough to ward off systemic, widespread municipal defaults that either were predicted by Wall Street analysts since the economic downturn, or that occurred in past recessions.

The fourth quarter growth was driven by a steadily-improving economy and was geographically broad-based, with 44 of the 50 states showing increases, U.S. Trust said.

Personal income tax revenues showed the strongest growth at the state level at 10.8%, followed by 2.7% growth in sales tax revenues, and 1.2% growth in corporate income tax revenues.

Overall, state tax revenues have grown for 12 consecutive quarters, andsurpassed the peak level,  of about 5.1% in 2008, U.S. Trust said,citing U.S. Census Bureau statistics. New Mexico led the growth, as tax revenues increased close to 20%, followed by New Hampshire and Hawaii, with the second and third largest growth. North Dakota experienced roughly a 1% increase -- the least of all the states that postedgrowth -- while some states, like Alabama, South Dakota, and New Jersey, had slight declines. Wyoming suffered the largest decrease at 15%.

While the 5.2% average growth trails the increasesin the economic recoveries following the two prior recessions in 1990 and 2001, U.S. Trust is still optimistic.

U.S. Trust analysts David Litvack, Martin Sullivan, and Marilyn Cruz wrote that  growth has paved the way for overall investment opportunity, though they see isolated risks.

“State and local governments still face stress from reductions in federal aid, and in some areas, large unfunded pension liabilities and weak housing values,” they wrote in an April 30 report.

“We believe these overall concerns are one of the reasons municipal bonds are currently trading at such high yields relative to Treasuries,” they wrote, The firm expects only “isolated defaults and bankruptcies” as federal and economic pressures will affect some credits more than others.

“Managers with strong research capabilities should be able to navigate a market sector trading at elevated yields due to overall concerns, while avoiding those credits most vulnerable to deterioration,” the analysts said.

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