Munis in Mind (Part 2)

Munis are not headed for a meltdown.

There are many reasons to be concerned about the muni market. Fraudulent disclosure on the part of the issuers, fraudulent bid-rigging on the part of correspondent banks, fraudulent off-balance sheet transactions on the part of municipal employees—you get the picture. But the criminal actions of a few public officials do not taint the entire $2.3 trillion dollar market.

Credit is a multifaceted thing. Rigorous analysis evaluates the borrower’s liquidity, solvency, efficiency, credibility, and growth. In plain language: how much cash do you have, how much have you borrowed, how much can you save, how much do people trust you, and how fast can you grow.

As an example, when Lehman failed, declines in bond prices wiped out their capital. They were insolvent. They weren’t efficient enough to grow their capital back, and when lenders realized the extent of the problem, they pulled their liquidity facilities. By September of ’08, poor management decisions had cost Lehman the credibility it needed to put a deal together. Failure was the result.

When we evaluate cities and states via the same matrix, we see a mixed picture. But we don’t see a meltdown happening. As an example, most municipalities have committed only about 10% of their budgets to paying principal and interest. By contrast, in 2007 67% of Lehman’s revenues were devoted to paying just interest. When times got tough, they couldn’t raise cash internally. Munis aren’t in that same boat.

It’s not easy to evaluate thousands of different issuers across the country. But when you run the numbers, munis seem pretty safe.

Douglas R. Tengdin, CFA
Chief Investment Officer
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