Protection on US municipal debt is currently more costly than that on US investment-grade corporate bonds. Spreads on Markit's five-year MCDX index, which references credit default swaps (CDS) on municipal bonds, were at 275 basis points as of December 19. Spreads on the investment-grade CDX.NA index were 222bp.
The shift took place on December 4, when spreads on the MCDX and the CDX.NA.IG closed at 284.38bp and 276.44bp, respectively. This is the first time this has occurred since the MCDX was launched on May 6.
Gavan Nolan, a London-based credit analyst at Markit, commented: "The current widening of Markit MCDX spreads reflects the perceived increase in municipal credit risk. A confluence of events - an economy in recession, decreasing home values and increasing unemployment - has combined to reduce municipalities' sources of income. Several municipalities have announced recently that they are experiencing financial difficulties."
The financial crisis and the resulting drop-off in tax receipts has led to lower revenues for many municipalities. "The existence of these strains - declining revenues, increasing budget gaps and higher levels of unemployment - create a lot of pressure that they then have to respond to, so it is our opinion that the outlook for the factors that are going on in this sector are negative; how any individual issuer will fare through that is dependent on how they manage these issues," according to Gail Sussman, New York-based group managing director of public finance at Moody's.
California, for example, saw $5 billion of its debt downgraded from SP-1 to SP-2 by Standard & Poor's on December 10 due to "sharp declines in revenue as a result of an economic slowdown", said credit analyst David Hitchcock.
Despite the pressure placed on these states by the market turmoil, Sussman believes municipalities pose less risk in general than corporate issuers. "Retail companies, for example, are waiting for November and December to see how they fare for the year. You don't really find that in government - they are ongoing entities and not paying debt service is the last thing they will resort to," she said. "All governmental entities are ongoing. They can't function without a balanced budget and will solve the problem by either raising revenues or cutting expenses - going out of business is not an option."
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