Muni Market Underpricing Credit Risk and Over Pricing Legal Security Pledge

Last week was a busy one in the municipal bond market.  The City of Detroit was ruled insolvent, clearing the way for bankruptcy negotiations to move forward.  If the ruling is upheld, it's a 'credit positive' for bondholders, as it establishes pension benefits as unsecured debt of the jurisdiction by classifying general obligation debt equivalent to unsecured debt and pension obligations. On the same day as the Detroit ruling, the State of Illinois approved modest pension reform. However, the State of Illinois still has significant fiscal imbalances and an updated actuarial study is needed to measure the impacts of the new reforms. As we wrote last week, the municipal market is underpricing credit risk and overestimating the power of legal security pledges in situations where the resources are simply not available to repay outstanding liabilities. SNW Asset Management's stringent credit analysis process has benefited our clients by avoiding exposure to these municipal credit issues.