As part of our standard municipal research process, each month we take a deep dive into a particular sector of the municipal market. In January it was the local general obligation sector, which includes entities such as cities, counties and school districts. SNWAM has a neutral outlook on the sector as generally good relative credit quality, constrained supply and supportive economic trends are offset by fairly priced trading levels. One key factor is the relative stability of local property tax revenues and the security provisions associated with most local GO bonds. The downside risk associated with the sector does not necessarily stem from the property tax pledge, but from potentially increased reliance on more volatile revenue sources and increasing costs from liabilities such as pensions. As such, we prefer local GOs with an unlimited tax pledge, which should mitigate downside risks. The local GO sector’s credit drivers include national economic factors such as employment growth, personal income growth, property price appreciation, retail sales and consumer spending. The primary source of revenue used to repay local GO debt service is property taxes. Given the importance of property taxes to the credit quality of the local GO sector, real estate market trends are critical in our sector credit analysis. We see the housing market continuing to perform well as measured by the 5.2% year/year increase of the S&P/Case Shiller U.S. National Home Price Index, as of October 2015. The 20-City Composite had a 5.5% increase during the same period. Price appreciation has been driven by strong sales, falling inventories and growing but limited new home construction. Housing starts are also projected to increase in the coming years. The rating agencies and the Street’s outlook also influence the local GO sector. Barclays, providing the street view, believes local GO credit quality will continue to improve in 2016, arguing that although quality has not fully recovered post-recession, sector performance should be in line with the market. Barclays’ analysts acknowledge that there may be some problem areas on the horizon, but if the U.S. economy continues to grow, they do not expect widespread deterioration in 2016. In the high-grade space, Dallas was downgraded by both Moody’s and S&P due to growing pension obligations.
Sources: Barclays, Moody’s, S&P