Top-Rated States' Yields Steady as Potential Downgrades Loom: Muni Credit

Top-graded states shrugged off the U.S. downgrade and a threat from rating companies to lower their credit scores as investors continued buying tax-exempt bonds.

Standard & Poor’s Aug. 5 cut the U.S. to AA+ as it believes Washington hasn’t done enough to curb spending or raise revenue to tackle record budget deficits. Yesterday the company said it may lower municipal credits after a bipartisan panel’s proposals in November to reduce expenditures. Moody’s Investors Service on July 19 put five AAA states on its watchlist for potential rating cuts because of dependency on federal funding.

Since then, demand for tax-exempt debt and Treasuries has soared as investors opt for safer assets amid market turmoil. Ten-year Treasury yields yesterday fell as low as 1.97 percent as rates on similar-maturity Canadian and British debt also reached all-time lows. Yields on 10-year U.S. top-rated tax- exempt bonds fell to 2.2 percent yesterday, the lowest since Sept. 6, according to data compiled by Bloomberg.

“We didn’t see much negative reaction to the downgrade of the U.S. credit, so there wasn’t much whiplash from that event - - which was a positive,” said Jason Hannon, a trader at Arbor Research & Trading Inc. in New York, referring to Moody’s warning about the five states. “Furthermore, buyers of munis still saw the strengths of these state credits.”

Yields on top-rated 10-year tax-exempt bonds have fallen by 22 basis points, or 0.22 percentage point, since Aug. 5. The drop for 10-year Treasuries was 50 basis points.

No Impact

Moody’s is reviewing Maryland, New Mexico, South Carolina, Tennessee and Virginia to determine how much risk federal spending cutbacks may present and whether to remove their AAA ratings. Trading of their long-term tax-exempt debt hasn’t altered significantly, said Eric Zurla, a trader at Butler Larsen Pierce & Co. Inc. in Greenwich, Connecticut.

“I haven’t seen much ramifications from that, Zurla said. ”The market has absorbed it because there’s not a lot of supply in any of those states. I don’t see much sell off in those names at all. With the way the overall market has performed over the last few weeks and rates keep pushing lower, these bonds are still doing pretty well.’’

A Maryland general-obligation bond issued in July 2010 and maturing August 2021 changed hands yesterday, the most recent trade, with an average yield of 2.23 percent, which is 4 basis points above an index of top-rated 10-year tax-exempt debt, Bloomberg data show. That compares with a trade on July 11, before Moody’s placed the state on review, when the bonds yielded 2.62 percent, 11 basis points below the index.

Credit Default Swaps

The cost of protecting $10 million of the state’s debt decreased to $81,700 a year on Aug. 18, after reaching $84.86 on Aug. 3, according to credit-default prices from CMA, which is owned by CME Group Inc. The year’s high was on Jan. 3 when the cost was $106.01.

A Virginia general-obligation bond issued in November 2008 and maturing in June 2026 last traded Aug.3 to yield 3.16 percent, 8 basis points below an index of top-rated 15-year tax- exempt securities. That’s compared with 19 basis points below the index on June 3.

The difference between top-ranked states and those with AA+ ratings is “insignificant” because “buyers are telling the market and issuers that these high-quality states have full reception,” said Chip Peebles, head of retail trading at Morgan Keegan Inc. in Memphis, Tennessee.

State debt is attractive because governors must match revenue with spending every year, unlike the federal government, which can rely on Treasury bonds to make up the difference, he said.

Balance the Budget

“Unlike the U.S. government, states are constitutionally required to balance their budgets,” Peebles said. “So if they receive less funding from the federal government, then they will have to cut elsewhere to balance their budgets. The federal government doesn’t have that requirement for now, so states will be forced to live smaller than they currently are, because of their constitutional constraints.”

Treasury yields have fallen faster than those for municipals. Tax-exempt yields represented about 106 percent of Treasuries, yesterday compared with an average of 91.5 percent in 2011, Bloomberg data show. Municipals and Treasuries became more expensive as investors dropped stocks after a U.S. credit- rating downgrade and economic data showing a slowing recovery.

Following is a description of a pending sale of municipal debt:

KING COUNTY, WASHINGTON, which encompasses Seattle, will sell $403 million of revenue bonds as soon as next week to help refund debt and finance improvements to the sewer system. The bonds are rated AA+, S&P’s second-highest grade. JPMorgan Chase & Co. will lead a syndicate of banks on the deal. (Added Aug. 19)

To contact the reporters on this story: Michelle Kaske in New York at mkaske@bloomberg.net; Sarah Frier in New York at sfrier1@bloomberg.net;

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net

• Facebook Share
• LinkedIn
• Google +1
• COMMENTS
• Print
• QUEUE