A Reality Check on the Municipal Bond Market | Lord Abbett
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Fixed-Income Insights

Our experts respond to several points raised in a recent Barron’s article.

Read time: 5 minutes



A recent Barron’s article on the municipal bond market ("Cities and States Are Facing Horrific Budget Holes. There Will Be More Trouble Ahead," August 29) contained a number of assertions that do not reflect our views of market conditions, especially with regard to the credit quality of key municipal sectors. Negative articles like these, though they may cause some concern among investors, have actually led to what we consider attractive yields on munis relative to other fixed income markets when compared on a tax-equivalent yield basis.

Here, we respond to some of the points raised in the Barron’s piece.

  1. Investment-grade municipal bonds have a historical default rate near 0%, based on data from Moody’s,1 and we believe they will continue to perform in a similar manner. When the Barron’s article mentions that the ratings agencies have negative outlooks on state credits, this does not mean that the agencies think states will be defaulting.  What it means, in our opinion, is that if a state is rated AA, the agencies believe there is a good chance the rating could go down to AA- or maybe, in the worst case, A+.  That is still well within the parameters of investment grade.
  2. The article expressed concerns about more defaults among general obligation (GO) bonds now than there have been historically.  While one can point to the bankruptcies of Detroit and Puerto Rico, that is about it for major defaults, so we believe this assertion is extremely misleading. GO bonds have strong legal protections to support their payment and all state and local governments rely on the municipal bond market to fund their infrastructure.  With Congress unable to agree on a new stimulus plan, it is clear to us that the states cannot rely on further stimulus funding at this time nor depend on the Federal government in the future. Therefore, we believe it is critical that they maintain their market access, and not act in a way that could diminish their credit standing. Puerto Rico stands as an example, as the Commonwealth cannot access the market so it instead has to ask Washington for money.  Other government issuers do not want to be in this situation.
  3. There is a perception that municipalities are burdened with high levels of debt; we would argue that this is not the case. According to Moody’s, state and local government debt now comprises 14% of U.S. GDP compared to 20% in 2010. In addition, annual debt service costs are typically less than 5% of expenditures for a state and less than 10% for local governments. These low debt levels allow municipalities to make sizable spending cuts without pitting bondholders against other essential priorities. Theoretically speaking, a government that spends 10% of its budget on debt service will spend only 12.5% after a 20% budget cut.
  4. More than 70% of municipal bonds issued are revenue bonds and not GOs.  This means that they are backed by specific revenues.  This includes water & sewer systems, utilities, hospitals, toll roads, universities, and airports. Some of these are essential services where revenues do not drop in all environments. Most of the essential service utilities benefit from having monopoly pricing power, reliable revenue streams, and strong security structure.  While revenues may have dipped during the pandemic, we believe many of these issuers continue to have a strong capacity to service their debt. The key point is that even though GOs get most of the attention, most of the attractive investments in municipal bonds are not GOs.
  5. While the U.S. economy has slowed down, it is important to remember that almost 90% of the workforce is still on the job if the unemployment rate is close to 10%. We all want to see the rate get back below 5%. Still, income taxes are not disappearing because of the virus slowdown, but are just a little bit lower and are still providing strong coverage for issuers who depend on tax payments.
  6. To be sure, there are clearly some investments that are under stress.  The New York Metropolitan Transportation Authority (MTA) is one.  People are not riding the subways at anywhere near the level they were prior to the pandemic. However, the MTA has state and Federal support, and it is a positive in our view that the agency was recently able to borrow from the Federal Reserve’s Municipal Liquidity Facility (MLF).  This move allowed the MTA to get a rate below 2% rather than paying the 2.8% the market wanted; we believe this is a positive development as it lowers the agency’s interest cost and reduces its financial stress as it awaits more government funding.  With New York remaining a vital commercial center, the U.S. economy cannot grow at or near its potential if the MTA cannot provide service, so the agency ultimately needs to be financed and we believe the Fed’s program is really helping.
  7. Ranking the states by financial strength, as the Barron’s article does, is an interesting exercise, but it doesn’t have much of an impact upon municipal bond investments.  Most U.S. states do not borrow much on their own and are not even represented in our portfolios.  The ones at the bottom of the list provide much better yields to investors because investors are all aware of their risks, and require extra compensation if they choose these bonds as investments.  A state like Illinois has had difficulties for years and the pandemic does add more stress.  Still, the state was able to create a balanced budget and eliminated the political brinksmanship that resulted in several years of budget passage delays.  Illinois is taking additional steps with the potential to create more revenue; it continues to need market access, so it is important to the state that it maintain its investment-grade rating.
  8. Local governments rely on real estate taxes mostly for their GOs.  Real estate is holding on fine and actually doing very well in a lot of the country, in our view. States rely more on income taxes and/or sales taxes.  We expect that income taxes will be down for this fiscal year but most people are working so tax revenues aren’t going to zero and states have made budgets with reduced projections.  Sales taxes have been recovering and are way off their lows of March and April so we don’t see them as a major problem at this point given some have just shifted to other types of sales such as internet purchases.
  9. Finally, the Barron’s piece cites the large amount of municipal bond debt being issued this summer as a potential problem. Once again, we believe this is misleading. We think that to truly understand muni supply, you have to look at what it’s being used for. Since interest rates are low, municipal bond issuers can refinance outstanding bonds at lower rates. It would be financial mismanagement if borrowers were not issuing new bonds at low rates to refinance older ones with higher rates. Furthermore, since the tax law from 2018 forbids them to refinance in tax exempt municipal bonds, they are doing most of the refinancing in taxable municipals.  This means that the tax-exempt municipal bond market is not seeing increased supply of new bonds so there is not supply pressure on the market at all. We think this increased issuance is a positive development; it is good for the market when muni issuers are lowering their interest rate expenses by refinancing at lower rates.

Summing Up

By not offering proper context, negative commentaries about municipal bonds such as the Barron’s piece discussed here provide what we would consider alarmist analysis. It does not represent a comprehensive review of the municipal bond market. Negative outlooks by ratings agencies in most cases suggest small credit quality moves and not defaults. Yes, the U.S. economy is much worse than it was before the pandemic, but it has not come close to totally stopping or putting states and local governments in default.

We maintain that there are a lot of great municipal bond investments that are not general obligation bonds, but GOs get a lot of the attention because of the headline value of outliers such as Puerto Rico and Detroit. Nonetheless, many of them remain attractive investments, in our view.  While there is clearly more stress in the municipal bond market now than in the past several years, we are confident that the muni sector’s strong historical credit quality will hold up and that investors will continue to receive tax-advantaged income and returns that are attractive relative to other investment choices.


1”US Municipal Bond Defaults and Recoveries, 1970-2018,” published August 2019.


A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Lower-rated investments may be subject to greater price volatility than higher-rated investments. A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

The information provided is for general informational purposes only. References to any specific securities, sectors or investment themes are for illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a reliable indicator of future results.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

General obligation (GO) bonds are backed by the “full faith and credit” of a government, and are issued by entities such as states, cities, counties, and school districts. Revenue bonds are backed by revenues from a specific projects or facilities (such as toll roads, water/sewer systems, or airports). 

The tax-equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of the tax-exempt yield on a municipal bond. This calculation can be used to fairly compare the yield of a tax-free bond to that of a taxable bond to see which bond has a higher applicable yield. The tax-equivalent return on a municipal bond reflects the tax-equivalent yield and price changes on the underlying securities.

The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education.  None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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