Investors Spurn U.S. States as Revenue Sets Record: Muni CreditMichael C. Bender and Brian Chappatta
From Florida to Michigan, states are readying record budgets as tax collections are set to exceed prerecession peaks. The achievement is going unrewarded in the $3.7 trillion U.S. municipal-bond market.
Even as states’ fiscal health improves, investors in local debt are bypassing the credits in favor of riskier securities as the Federal Reserve keeps its benchmark overnight interest rate near zero. State general-obligations are on pace to trail the rest of the market for the ninth straight quarter, the longest stretch since 2007, Bank of America Merrill Lynch data show.
Tax revenue in the 50 states this year will surpass the record of $670 billion from 2008, said Todd Haggerty, who tracks budget issues for the Denver-based National Conference of State Legislatures. Still, with an average credit rating one step higher than the typical muni obligation nationwide, state securities aren’t appealing enough with local interest rates falling toward historic lows.
State borrowings “tend to yield less than the broader market and we think the most positive driver of returns in 2013 for muni bonds is going to be yield,” said Michael Zezas, head of muni strategy at Morgan Stanley in New York. “The relative risk-reward is less favorable than other muni sectors.”
Florida and Michigan join states including Ohio and Texas charting record spending plans. The economic health of 44 states improved in the fourth quarter amid growing employment and personal income, according to the Bloomberg Economic Evaluation of the States index. The gains were the most since 2006, the year before the 18-month recession began.
Rising personal-income tax collections are driving much of the spending increase, and taxes on sales and real estate transactions are also up, said Haggerty at the NCSL.
“Most states are returning to that peak, which is why projected budget levels are expected to go up,” he said in an interview. “We’re seeing a gradual improvement.”
The recession reduced state general-fund revenue to about $604 billion in 2010, according to the NCSL. The deterioration fueled anti-spending sentiments in the 2010 elections, embodied by the Tea Party movement as federal lawmakers debated the health-care law.
Even with the fiscal rebound, state bonds can’t keep up. The average state borrowing yields about 1.45 percent, compared with 2.18 percent for the rest of the market, Bank of America index data show. The yield spread of about 0.73 percentage point is close to the smallest since June 2010, showing the broader market is outpacing state debt.
State general obligations have an average rating of Aa2, the third-highest grade from Moody’s Investors Service, in Bank of America’s index. The broad market is one level lower.
“Because they’re at the top of municipal credit, they tend to trade on the expensive side, and yields are lower,” said Peter Hayes, head of munis at New York-based BlackRock Inc., which oversees $114 billion of local debt. “It may not be the best way for people to maximize income, but for those who are worried about safety and liquidity, state G.O.s are the best way to express that.”
The Washington-based National Association of State Budget Officers estimates that general-fund spending for fiscal 2014 will surpass its prerecession high.
In Florida, which has a AAA credit rating from Standard & Poor’s, legislators are ready to vote on a $74.5 billion budget, which exceeds by $855 million the previous high set seven years ago.
In Ohio on April 18, the House of Representatives passed a two-year $61.5 billion budget, which would be a record. In Texas, where lawmakers approve a two-year spending plan, the general-revenue budget will be a record, based on initial plans from legislators.
Michigan Governor Rick Snyder’s proposed $50.8 billion budget for 2013-14 would be the state’s largest ever. It includes an all-time high $29.5 billion from state taxes and fees. While the senate hasn’t completed its budget, the house spending plan would be the largest ever, though it doesn’t include money to expand Medicaid, as Snyder proposed.
Republicans hold the governor’s office and majorities in the legislature in all four states.
The plan from Florida Governor Rick Scott, a Republican who proposed a record-breaking $74.2 billion budget this year, included about $730 million in new debt for highway and seaport construction.
The state averaged $2.2 billion in new-money debt issuance annually from 2002 to 2010. During Scott’s time in office, 2011 was the biggest year for new debt issuance, with $888 million. House and senate lawmakers have proposed spending cash on college construction, usually the biggest driver of state debt.
A former chief executive officer at HCA Holdings Inc., Scott, 60, financed his own Tea Party group in 2009 before spending $70 million of his own money to win the governor’s office. His approval ratings have exceeded 39 percent just once in 15 surveys of registered Florida voters since taking office, according to Hamden, Connecticut-based Quinnipiac University.
Scott, facing re-election next year, wants to spend $18.5 billion on education, a 7 percent increase from this year and the most since 2007-08. Upon taking office in 2011, Scott asked lawmakers to cut $3.3 billion from the prekindergarten through university budgets.
In another reversal, the Florida governor now backs Medicaid expansion in the face of opposition from lawmakers. He is among several Republican governors pushing to expand Medicaid, the federal program providing health-care coverage for the poor. These governors have faced opposition from state lawmakers in their own party. At least eight of 30 Republican governors have backed Medicaid expansion.
“This is a growth budget,” Scott told reporters at the Capitol this month.
Republican lawmakers in Florida, who have controlled the legislature since 1996, propose spending more than Scott requested. They plan to complete the budget by May 3, the last day of the session.
In the new issuance market, the Iowa Finance Authority plans to offer $1.2 billion in tax-exempt bonds today for a fertilizer plant, in the biggest high-yield muni borrowing since at least 1990.
The deal makes up about 20 percent of issuance this week, the smallest supply wave since March. New Jersey’s postponed $350 million general-obligation issue is set to price May 1 via competitive sale.
Ten-year benchmark munis yield 1.75 percent, close to the lowest since January. The tax-exempt bonds are still cheaper than similar-maturity Treasuries, which yield 1.67 percent.
The yield ratio between the two securities is 105 percent, close to the highest in about two weeks. The greater the figure, the less expensive munis are compared with federal debt.