Fitch warns muni investors on downgrades

Investors who have piled into US municipal debt face rating downgrades on their bonds next year, a leading credit rating agency is warning.

Fitch says that local government is still far from a recovery from the effects of the financial crisis and recession on the US economy. The agency expects to downgrade dozens or hundreds of issuers in 2013.

The forecast, in the annual outlook report published on Monday, could disappoint investors whose buying spree has pushed yields on muni bonds to their lowest levels in 45 years.

Income from property taxes will stay depressed, as it is based on home prices still resetting at lower assessment valuations, Fitch said. Contributions to public sector pension funds are having to be stepped up, to fill holes that opened when markets crashed in 2008.

Amy Laskey, managing director in Fitch’s US public finance group, said downgrades would persist at an above-average rate in 2013: “Governments that took [recession] seriously are in better shape than those that spent the first years dipping into reserves or patching over the deficit.”

A Bond Buyer index measuring 20-year general obligation bonds from municipalities US-wide recorded a 3.29 per cent yield last week – the lowest since 1967. A month ago, the yield was 3.68 per cent.

Investor money has been flowing consistently into munis for more than a year. The buying spree intensified after the election. Washington’s budget negotiations are considered likely to lead to higher income taxes for top earners and increased taxes on dividends and other investments, an outcome which will make tax-exempt munis relatively more attractive to own.

By EPFR data, $50.8bn has flowed into mutual funds and exchange traded funds that specialise in municipal debt to date this year, compared with an outflow of $18.1bn in 2011. There has not been any week this year in which the sector has shown a net outflow.

Rick Taormina, head of Tax Aware Fixed Income at JPMorgan Asset Management, said the inflows came at a time of slow issuance by local authorities, pushing prices higher still.

“The technicals and the tax issues really seem to be overriding and pushing out the credit landscape,” he said. “The lower quality you are and the longer duration you are, the better you have done, and that is the reverse of what you would expect in an environment where downgrades vastly outnumber upgrades.”