Portfolio Manager Commentary – Warren Pierson on the Jefferson County, Ala., bankruptcy filing and the rise in municipal downgrades

November 10, 2011
Jefferson County, AL Bankruptcy
The widely-anticipated bankruptcy filing of Jefferson County, Alabama finally occurred yesterday and while we continue to believe that outright municipal bankruptcies will be few and far between, it does speak to the ongoing challenges in municipal finance. Weaker than expected economic growth is resulting in continued soft top-line municipal revenues (income tax, sales tax and property tax), causing tremendous stress and strain on municipal budgets at all levels that are confronted with burdensome expenses (e.g. employee retirement and healthcare benefits) that had been more manageable in bygone, higher growth eras.

Beware of Downgrades
Recognizing that municipal bankruptcies and defaults are rising (but still relatively rare), our greater concern continues to be a general decline in credit quality. Indeed, Moody’s recently announced that in the 3rd quarter, their downgrades in the municipal market outnumbered upgrades by a margin of 5 to 1 and investors should be aware that downgrades are typically accompanied by price declines. For example, a 10-year bond that gets downgraded from AA to A could easily experience an associated price decline of 5-6%. Headlines like yesterday’s will likely focus more market attention on the changing landscape in municipal finance and we believe investors should be wary of credit risk in the municipal market at this juncture and the potential for many more downgrades in the months (and years) to come.

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here are our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee accuracy.