Munis, Defaults, Chicago

Author: David R. Kotok, Post Date: July 11, 2017
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In her quarterly missive, Cumberland’s Patty Healy offered a terrific summary of credit conditions in the US muni market. Here’s that commentary:cumber.com/2q-2017-municipal-credit. John Mousseau furthered a dissection of the subject on Asset TV. See assettv.com/video/changing-municipal-landscape

Let’s add to this conversation and end with an investment conclusion.

On June 27th, Moody’s issued a massive report entitled “US Municipal Bond Defaults and Recoveries, 1970–2016.” This 101-page document is a wealth of information and a muni bond manager’s bread and butter reference. For those able to obtain this report, we highly recommend it.

Moody’s notes that last year’s $22.6 billion “debt affected” total constituted “by far the highest annual default volume in the 47-year study period.” Puerto Rico was the poster child among defaulters and is likely to retain that dubious distinction this year as it continues its huge debt-restructuring process. Note that Cumberland has a specific PR bond management program utilizing certain insured PR debt, and all payments of interest and principal have been made to the bondholders in a timely way on the bonds held in that strategy. We advise that each bond be deeply researched: Just blindly buying any insured PR bond is not advisable. There are many nuances involved in this credit work.

Ex-PR, Moody’s notes that “defaults and bankruptcies have become more common in the last decade, but are still rare overall.” The five-year municipal default rate since 2007 was 0.15%, as compared to the five-year global corporate bond default rate, which was 6.92% since 2007, according to Moody’s.

At Cumberland, we favor muni credit in both tax-free and taxable forms, although we do use corporate credit in a managed portfolio structure where a client has authorized it. Muni credit is complex and requires skillful analysis. That is one of the strengths of our firm, and we have over four decades of hands-on experience. This writer recalls that his first tax-free muni issue advisory role was in 1974.

Perhaps the biggest looming muni credit problem is the one plaguing the State of Illinois. Illinois must contend with about $15 billion in unpaid bills and about $250 billion of unfunded pension and retirement benefit promises. The state is a prime exhibit in dysfunctional governance. It is losing population and has been shrinking a tax base, but its legislature is working to raise taxes, out of necessity, on who and what remains in this very large and once highly creditworthy state.

At Cumberland, we will not own bonds issued by such a political construction, so our Illinois muni positions are very limited to specific issues that are protected by priority claims for essential-services revenues. Note the contrast with an AAA credit like Utah, with its growing population and expanding tax base.

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