In this review of muni bond trouble spots, James Dearborn notes that the biggest concern in munis right now is pension funding.
Only Four of 126 State Pensions Are Fully Funded
Many state and local governments are faced with underfunded pensions. Head of Municipal Bond Investments and Senior Portfolio Manager James Dearborn explains how pension funding issues are making some issuers vulnerable to multiple notch downgrades by credit rating agencies. He also highlights Puerto Rico’s budget situation as a lesson to muni bondholders on the importance of credit research.
Clint Carlson's Carlson Capital Double Black Diamond fund returned 3.34% in August net of fees. Following this performance, the fund is up 8.82% year-to-date net, according to a copy of the firm's August investor update, which ValueWalk has been able to review. On a gross basis, the Double Black Diamond fund added 4.55% in August Read More
We spend a lot of time looking for problems amongst our borrowers and the borrowers we're considering.
The biggest issue for us right now in terms of credit quality is pension funding.
Many state and local governments are behind the eight ball in terms of covering growing pension cost. They haven't put enough in over the years and they now need to expand the amount that they send to their pension systems every year to try and catch up. Those increased costs are curtailing the amount of the budget they have for everything else. In certain places, that pressure is extreme, in New Jersey, in Illinois, growing in Connecticut, in Pennsylvania. And in local governments, Chicago is obviously one of the areas that we're focused on.
A good example of places that are having real trouble funding their pension is Dallas, Texas. Dallas, Texas forever was a triple A rated credit. Underfunding pensions and very generous pension provisions have left them in a place where they're having trouble keeping up with the amount of money they need to put in the pension system just to keep it solvent. The rating agencies have reacted very negatively to this situation with multiple notch downgrades for what was once a very stellar credit in our market.
What's happening now in Puerto Rico is very sad. Unfortunately, it was also very predictable. For years, the Commonwealth borrowed money at the end of every year to cover a gap in their budget. That's unsustainable and that's part of the reason why we had the rating below investment grade 10 years ago.
Today Puerto Rico's at a point where they're making a decision about how much they can pay bond holders. Recent analysis indicates that it could be as little as 25 cents on the dollar that their existing bond holders will get in terms of recovery. What's happening in Puerto Rico now is a testament to the need for strong municipal credit analysis.
Article by James Dearborn, Columbia Threadneedle Investments