As part of our investment process, SNWAM bond analysts make weighting recommendations for each sector in the municipal bond market, in addition to reviewing each credit held in SNWAM managed portfolios. Each month, a specific sector is the subject of an in-depth review, which includes an analysis of the sector’s relative credit quality, issuance trends and pricing relative to other sectors in the muni market. The State General Obligation sector was the focus of SNWAM analysts’ December muni sector review.
The State GO sector has benefitted from relatively good credit quality, which is expected to continue into 2016, and the level of issuance is also expected to be in line with current trends. Pricing of bonds in the sector has also been relatively stable. We expect that the sector will benefit from a growing economy, which has provided a stable foundation for state revenues. State revenues grew by 5.6% in Fiscal Year 2015, fueled by a 9% gain in personal income taxes during the year. Personal income tax growth was driven by the performance of the equity markets in calendar year 2014. As equity returns have moderated in 2015, we expect lower levels of revenue growth in FY 2016. A key to sector quality has been the ability of states to restrain spending and build reserves. The state GO sector has also benefitted from an increase in the funding level of pensions, which rose to 80% of pension liabilities in FY 2014, and we expect the growth of unfunded pension liabilities to be constrained by recent pension reforms. A slowdown or economic recession in combination with any increase in cost pressures from K-12 education, as well as from healthcare and pension liabilities, presents risks to the sector, particularly as the level of accumulated reserves is less than amounts accumulated in prior periods of economic growth.
Sources: Rockefeller Institute of Government, Moody’s, Wilshire Consulting, Center for Retirement Research at Boston Colleg