Revenue Rebound Seen Buoying Even the Worst States: Muni Credit

U.S. state revenue collections may grow 30 percent faster than a year earlier, boosting investor interest in the governments’ debt as borrowing costs in the $3.7 trillion municipal market hold near 45-year lows.

Improving revenue has allowed some states to rebuild reserves tapped in the wake of the 18-month recession that ended more than three years ago as they face looming federal budget cuts and lingering unemployment, the National Conference of State Legislatures said in a report today. A quickening fiscal rebound may allow state debt to outperform cities after trailing the past seven months, the longest stretch since 2007.

“If I were a buyer, I think I’d have a particular interest” in state general-obligations, said Chris Mier, chief muni strategist at Loop Capital Markets in Chicago. “They were the first to get hit in the crisis and the first to recover.”

Budget officials in 32 states project the economy will remain stable this year, even as potential federal budget cuts and a national jobless rate that has exceeded 8 percent since early 2009 leave finances vulnerable, according to a report by the Denver-based legislatures’ group. States forecast revenue will climb 3.7 percent this year, up from a 2.9 percent clip in the prior 12 months.

Lowest Ratings

Climbing collections are helping spur buying of even the lowest-rated state debt. The extra yield investors demand of issuers from California and Illinois, which have credit grades below all other states, is close to the lowest this year, Bloomberg Fair Value data show. The states are among the majority projecting revenue growth over last fiscal year.

“State budgets still face considerable challenges,” the NCSL said. “Fortunately, state budgets today are better positioned to handle these challenges.”

With the Federal Reserve holding benchmark overnight interest rates near zero and budget-cutting politicians paring local-government debt for the first time since 1996, municipal borrowing costs have held at the lowest in a generation.

Today’s report is the latest to signal states’ emerging fiscal stability, after the worst recession since the 1930s depressed tax intake and boosted demand for services such as Medicaid, the health-care program for the poor. Last week, the Nelson A. Rockefeller Institute of Government said collections from April to May signaled a 10th straight quarterly gain.

44 States

Revenue is forecast to rise in 44 states this fiscal year, the same number as 2012, led by states including California and Florida, the legislatures’ group said. Five project declines, including Michigan.

The yield spread for issuers from Illinois, which faced as much as $8 billion of unpaid bills at the end of June, was as slim as 1.51 percentage points above AAAs last month, the smallest since February 2011, data compiled by Bloomberg show.

The spread between lower- and higher-rated states may widen with any new fiscal setbacks, said Richard Ciccarone, director of fixed-income research in Chicago for McDonnell Investment Management LLC, which owns more than $8 billion in munis.

“If you’re going to buy something at a high price, you want to make sure it’s a real diamond,” he said. “Right now, the market isn’t necessarily making that distinction.”

The financial stress hasn’t disappeared. Revenue hasn’t rebounded as swiftly as following previous recessions, and nearly half of officials surveyed said the cost of Medicaid is threatening to squeeze their budgets.

Federal Cuts

Officials in 10 states, including Massachusetts, cited concern that federal budget cuts may strain their fiscal outlook, according to the report. Unless Congress acts, the federal government in January may begin implementing $1.2 trillion of spending reductions planned as part of the accord struck last year to shrink the federal deficit.

As a result, local governments are focusing on refinancing debt instead of selling new bonds for public works.

While municipal issuance has risen 66 percent from last year’s pace, financing for new projects is up only about 8 percent as of the end of July, according to Citigroup Inc. Diminished need for projects as the economic rebound slows is contributing to the restraint, the bank said.

Minnesota plans to sell about $659 million of general-obligation debt as soon as today, some of which will go toward highway improvements, data compiled by Bloomberg show.

Still, Chris Mauro, head muni strategist at RBC Capital Markets LLC in New York, said he doesn’t anticipate the trend of restrained spending will reverse soon.

“Things are better, but we think the recovery’s fragile and can be quickly reversed,” he said. “Given the economic outlook, I wouldn’t be surprised to see continued austerity on the part of state governments in terms of their capital spending.”

Following are pending sales:

SAN FRANCISCO is set to sell $290 million of general-obligation debt through competitive bid as soon as Aug. 14, data compiled by Bloomberg show. Fitch Ratings grades the bonds AA-, fourth-highest. (Added Aug. 6)

CHICAGO plans to issue about $1.2 billion of revenue bonds for O’Hare International Airport to refinance debt, according to bond documents. About $729 million of the offer will consist of general airport senior-lien revenue debt, set to price as soon as Aug. 8, data compiled by Bloomberg show. (Updated Aug. 6)

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