States Underperform With Revenue Up, Slow Borrowing: Muni Credit

Massachusetts scaling back a bond offer by 40 percent this week shows how states are failing to win over investors even as governments add debt at the slowest rate in 20 years and rake in the most revenue since 2007.

As an expanding U.S. economy draws buyers to the extra risk of higher-yielding securities, state issuers can’t keep up. Their bond returns are trailing the rest of the $3.7 trillion local market for the ninth straight quarter, the longest losing streak since 2007, Bank of America Merrill Lynch data show.

Although yields are near historic lows, the states’ debt growth slowed to 1.3 percent in 2012, compared with a 10-year average of 7 percent, Moody’s Investors Service said last week. Officials are more inclined to refinance than borrow for new projects. Increased scarcity isn’t luring buyers to the bonds, which offer a yield spread over benchmark debt that’s only about a third of the average muni, Bank of America data show.

“That works against them,” said Michael Zezas, head of muni strategy at Morgan Stanley in New York. “There’s less of a cushion in terms of total returns” as signs of a growing economy boost prospects that interest rates will rise.

Revenue Rebound

State tax revenue rose from January to March for the 13th straight quarter, driven by the strongest growth in personal income-tax collections since the 18-month recession started in 2007, the Nelson A. Rockefeller Institute of Government in Albany, New York, said yesterday. An improving economy and higher income levies fueled the growth.

State obligations have lost 0.2 percent this year, compared with a return of 0.1 percent for the broader market, according to Bank of America data. The governments have an average credit rating two steps below the top grade, or one level higher than the typical muni, the bank’s data show.

Massachusetts, with an Aa1 Moody’s rating, one step below the top, reduced its general-obligation sale to about $669 million from a planned $1.1 billion, Bloomberg data show. The offer came as benchmark 10-year muni yields were close to a 15-month high.

Higher interest rates meant some of the refinancing debt no longer saved enough money, said Colin MacNaught, assistant treasurer of Massachusetts.

Volatility Hurdle

“We don’t want to price into an interest-rate environment in which rates are volatile like they are currently,” he said in an interview. The state will come back to the market to sell more debt, he said.

“We didn’t think there was enough demand to purchase our bonds at a price and a structure that we’re comfortable with,” he said.

The state priced refunding bonds maturing in August 2023 to yield 2.38 percent, or 0.2 percentage point above benchmark munis, Bloomberg data show.

Localities are refinancing higher-cost debt as speculation builds that interest rates are set to rise from near generational lows. Yields on 10-year Treasuries will climb about 0.4 percentage point to 2.52 percent in a year, according to the median forecast of 65 analysts in a Bloomberg survey.

Refunding helped slow the growth in debt-service costs to 3 percent last year, compared with 8.6 percent in 2011, Moody’s said. Such sales have made up about 61 percent of muni offerings this year as of April 25, close to the highest rate since 1993, according to Bank of America data.

Debt Decline

Kansas and Utah saw the biggest drops in net tax-supported debt on a percentage basis, with declines of 8 percent and 7 percent, respectively. Utah Treasurer Richard Ellis said in an e-mail that improving collections cleared the way to pay for projects with cash.

“We have had stronger revenues and have earmarked funds to allow for infrastructure investment,” he said.

For AllianceBernstein LP, which manages $31 billion of munis, state economies haven’t improved enough.

“We’ve been a bit more conservative and have tended to favor revenue bonds as state budgets and local budgets have been stressed,” said Joseph Rosenblum, director of muni credit research in New York. “As revenues recover, rebuilding reserves is something we’re looking to see as well.”

Muni yields are on pace to rise for the fifth straight week for the first time since April 2011. Issuers have ratcheted back scheduled offerings over the next 30 days close to the lowest since March.

At 2.19 percent, yields on benchmark 10-year munis have exceeded the interest rate on similar-maturity Treasuries for five straight days, the longest stretch in a month.

The ratio of the yields, a gauge of relative value, is about 105 percent. The higher the percentage, the cheaper munis are compared with Treasuries.

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