Harrisburg, PA has been in the news of late as a city that is struggling to stay out of bankruptcy. Because of this story, and stories of other U.S. cities facing potential bankruptcy, many municipal bond investors are monitoring these developments. The dual problem of too much debt and declining property tax revenues has culminated for several large cities and smaller municipalities due to the lingering recession. High-profile stories in the media, one of which was a 60 Minutes feature two months ago, have raised fear that widespread pain could be on the way in the municipal bond sector. The concern is that Harrisburg and other struggling municipalities nationwide could ultimately restructure their debt through default, causing bondholders to lose a portion of their investment.
A closer analysis of the situation, however, should lower the concern for holders of higher-quality municipal debt. To begin with, a spike in defaults that would reach $100 billion (as predicted by Meredith Whitney, an expert equity research analyst and CEO of Meredith Whitney Advisory Group, LLC) would represent 0.37% of the total $2.7 trillion in municipal bonds outstanding in the U.S. Additionally, two-thirds of the municipal issues are unrated. These unrated bonds represent just a fraction of the total market in terms of capitalization, but are the main concern of analysts in terms of potential defaults. Investors who hold investment-grade debt (BBB and higher) and who have taken the time and effort to look into the source of the cash flow that service the interest payments on the bonds should be careful not to get caught up in the media-driven hype.
As with any investment, there is risk in municipal bonds. However, given the inherent protections built into municipal bond issues, as well as the recent sell-off in the market, the municipal bonds market does offer a continuing opportunity for taxable investors.
For further information, please contact Pat Fisher, Schneider Downs Wealth Management Advisors, LLP.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.