Finding Undervalued Municipal Bonds

In our ongoing efforts to add value for our client, SNWAM constantly searches for mispriced and undervalued issuers and sectors.  You may remember that at the peak of the budget crisis in California, we were adamant buyers of select California credits across all accounts (including non-California residents).  Throughout the Meredith Whitney inspired sell-off in the broad municipal market in late 2010 and early 2011, we took advantage of the opportunity to buy many securities at deep discounts to their recent (and current) prices because we were confident in our ability to understand the fundamental credits.  We are continuing the effort to find bonds that have underperformed recently and offer excess value as we look for credits in the troubled state of Illinois.  We have identified a select group of names that have strong credit profiles, and which offer significant yield because of the shadow cast over them by the state’s credit issues.  The state will continue to struggle for the foreseeable future, but these credits maintain solid operating metrics, balance sheets with comfortable reserves, and strong debt covenants.  An example is the Chicago Board of Education unlimited tax general obligation bonds, which are issued on behalf of the Chicago public school district and are backed by both the district’s allocation of personal property tax replacement revenues from the state as well as an ad valorem property tax pledge, unlimited as to rate or amount, on all taxable property in the district, which is substantial at approximately $231 billion.  The general fund operations were positive in their most recent fiscal year, with an operating ratio of 107%, and the current fund balance as a percent of expenditures is 22%, which provides a material buffer against any change in operating performance.  Additionally, the district has a separately funded and accounted for debt service fund, which has 1.6x annual debt service in cash and amply covers annual debt service requirements without dipping into this balance.  While off-balance sheet liabilities are substantial, they are still manageable at this point and not crippling the issuer unlike those at the state level, for example.  It is also important to note that this is a separate legal entity from the City of Chicago, which along with Illinois, is struggling mightily.  Therefore the district it is not affected directly by actions (or inactions) of the city itself.  By conducting our own credit research and doing the appropriate legwork rather than relying on ratings agencies, we have been able to confidently make purchases in the face of market adversity.