Muniland’s bad boys

March 22, 2012

Last week I called Puerto Rico “America’s Greece” partly because of its financial statistics and partly because of its inclusion in the muniland bad-boy list maintained by Thomson Reuters Municipal Market Data. What the bad-boy list tells us is how much the bonds of the weakest issuers trade over the AAA benchmark. To put it another way, that difference is the premium the market charges for the risk of owning these bonds; it also reflects the premium the bad-boy issuers would have to pay to bring new bonds to market. For example, Puerto Rico, currently the weakest borrower on the list, would have to pay 225 basis points more than a AAA 10-year bond to borrow. Given that MMD AAA benchmark closed on Tuesday at 2.33 percent, that would mean an investor would demand a yield of 4.58 percent to buy a 10-year Puerto Rico general obligation bond. Also using Tuesday’s numbers, investors would demand a yield of 3.88 percent to own a 10-year California GO bond. This is how the market works — it punishes the weak.

Studying the chart above and table below you get a sense of the relationship between credit quality and the interest surcharge. The weaker the credit quality — that is, the lower the number or rating — the higher the interest paid. There are other factors that affect the premium, including the tax rates in the state (higher-taxed and wealthier states have lots of demand from their citizens for tax-exempt municipal bonds) and the recent supply of new bonds in the state. But the fundamental bond market truism remains: The riskier you are, the higher the interest rate you pay. In muniland these are the bad boys.

Issuer Spread S&P rating Moody’s rating Debt & unfunded pensions
Puerto Rico 225 BBB (6) Baa1 (6.5) $ 64 B
Illinois 155 A+ (8) A2 (9) $ 86 B
California 90 A- (7) A1 (8) $ 137 B
Nevada 65 AA (9) Aa2 (9) $ 4 B
Rhode Island 55 AA (9) Aa2 (9) $ 6 B
Michigan 53 AA- (8.5) Aa2 (9) $ 19 B
D.C. 43 A+ (8) Aa2 (9) $ 6 B
New York City 43 AA (9) Aa2 (9) $ 161 B
Ohio 35 AA+ (9.5) Aa1 (9.5) $ 14 B
New Jersey 30 AA- (8.5) Aa3 (8.5) $ 60  B

Source: Municipal MarketData, Moody’s Investors Service, Standard & Poor’s Ratings Services, local government budget reports, official statements.

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