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<h3>James A. Klotz</h3>

James A. Klotz

It barely registers on the radar of financial chat shows, a blip amid the fantastic prognostications of pundits.

If you look carefully, however, you’ll find it: A steady, if unspectacular stream of recent news items that indicate the municipal bond market – bashed almost gleefully by doomsayers a little more than two years ago – is getting healthy.

Multi-pronged recovery

Though they don’t make sensational headlines, there are numerous promising signs:

  • After cutting about 500,000 workers in the past five years, state and local governments are set to add employees this year, according to Bloomberg.
  • Expenditures and investment are expected to rise by 1.85% in 2013, three times the rate of last year.
  • Tax revenues of state governments have increased for 11 straight quarters, while local municipalities’ tax collections grew at 2.6% at the end of last year, the first  increase in three years, according to Morningstar.
  • Analysts estimate new muni defaults amounted to $1.7 billion last year, down from $6.5 billion the previous year, a miniscule figure (less than a half of 1%) in the  $3.7 trillion muni bond market.
  • Construction is up, home prices are on the rebound and state and local leaders have, for the most part, made significant gains in getting their fiscal affairs in order.

Even California, the state many referred to as a fiscal basket case, has a dramatically different outlook today than it did during the throes of the recession. Last week, the state sold $2.1 billion in general-obligation bonds, the first time it borrowed money since S&P raised its credit rating in January.

While the state raised yields on some longer-bond maturities to complete the sale, it’s been a remarkable turnaround.

“All factors considered, including investor sentiment that has become less accommodating to issuers in the last couple of weeks, we’re very pleased with the results,” a spokesman for Treasurer Bill Lockyer told Bloomberg. “We came into a tough market with a large amount of new supply and obtained a good result for taxpayers.”

As we previously pointed out (California’s Finances Riding a Wave), the state that once faced massive deficits now projects a small surplus.

Threats remain

It’s not all clear skies for state and local governments. Many still face underfunded pension obligations. Health-care costs may rise and there is a threat of cuts in federal aid. Rating agencies are expected to downgrade a number of issuers this year, and some efforts aimed at reducing or eliminating the tax benefit of municipal bonds remain.

Nevertheless, muni investors have plenty to cheer about – and they’re showing it in their healthy appetite for bonds.

Officials have shown the willingness and possess the tools necessary to tackle seemingly intractable financial difficulties. Significant threats to the current status of munis seem to have abated. An increasingly loud and influential consensus of budget officials from across the nation has emerged, warning that altering the muni-bond tax exemption would threaten the country’s nascent economic recovery.

It doesn’t make for dynamic television, but there is good news for investors focused on generating tax-free income. The market that lacks the pizzazz necessary for a good televised debate is returning to its staid, dependable ways. Just the way we like it.

James A. Klotz is the President of FMSbonds, Inc.
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Mar 19, 2013

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.