Muni Industry Optimistic About State Revenues Recovery

A growing number of municipal bond experts believe state and local government revenues will return to pre-crisis levels within two years, reflecting their optimism that the worst fears about rising defaults may not be realized.

Recovery sign
Recovery sign

Many of those surveyed in a poll by RBC Capital Markets have become more confident about the effect of a US economic recovery on local tax revenues.

Some 27 percent of the 100 municipal bond issuers, bankers and lawyers questioned at a recent conference sponsored by The Bond Buyer expect it will take two years for state and local government revenues to return to pre-crisis levels.

This compares with just 3 percent in a similar survey last October.

Some 23 percent expect the recovery to take five years or more, down from 46 percent.

“It is a reflection of the generally positive economic news including the performance of the stock market and, from a ‘muni’ perspective, state revenues clearly bottomed a few quarters ago,” said Chris Mauro, director of municipal bond research at RBC Capital Markets.

More than half of those surveyed on February 14 and 15, however, expect defaults this year to be the same as in 2010 when they totaled $ 2.7 billion according to data from Distressed Debt Securities Newsletter, which tracks muni defaults.

That level of expected defaults is higher than the average of $2.1 billion during the past 30 years and expectations of less than $2 billion in last year’s survey.

But it is well below some of the worst fears for defaults for this area of the bond market.

A recovery in economic growth will be crucial to a reversal in budget shortfalls and restoring the confidence of traditional “muni” investors, who have withdrawn more than $26billion from muni bond funds since November.

Outflows are slowing and the market has recently rebounded.

Some investors, such as hedge fundsand other money managers who are not traditional buyers, are mobilizing for further declines in muni bonds.

Most munis are bought by local individuals, directly or through mutual funds, because they offer tax breaks.

“A line is clearly being drawn in the sand,” Rob Novembre, head of municipals at Arbor Research and Trading, said in a research note last week.

States and local governments derive much of their revenue from income, sales and property taxes, which ebb and flow depending on job growth, consumer spending and real estate values.

Preliminary figures for October to December for 41 states showed that collections rose 6.9 percent compared with a year earlier, according to the Nelson A Rockefeller Institute of Government.

If confirmed in the full fourth-quarter data, the gain would be the most since the second quarter of 2006, the research group said.

All 50 states except Vermont must balance their budget annually. They have slashed spending and, in some cases, raised taxes, to close gaps.

The lingering effect of federal stimulus, which has supported local economies for the past few years, also largely phases out this year.

“One significant risk that is rearing its ugly head again is the price of oil,” Mr Novembre said. “What will happen to the efforts of states if oil rises and stays at a point which unleashes another recession on the US and world economy just as they were enjoying improved revenue streams in an upward economic cycle?”