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Thursday, February 3, 2011

Local municipal bonds could be more attractive than state munis (published in March of 2010 in the SB News Press)

This week, before an Assembly committee, state employees tried to explain why even as the state was struggling with ways to close last year's $60 billion deficit, and even in the face of executive orders to reduce purchases, government employees still went on a spending spree of massive proportions. They bought furnishings that cost as much as $7,000 per employee, a nearly $1 million airplane for a Caltrans inspector, a $429,000 boat and 1,300 cars, motorcycles and trucks costing $34 million.
"I just don't think it passes the smell test with everything we are going through right now," Assemblyman Nathan Fletcher, R-San Diego, said of the $1.4 million in DMV purchases that averaged $7,000 per employee work station. Gov. Schwarzenegger last year ordered departments to make 15 percent cuts on spending for contracts and purchases, and to buy no non-emergency vehicles.
The 1,300 vehicles purchased were in addition to $17 million worth of new cars for the California Highway Patrol and the $968,000 Caltrans airplane will require payments over the next 10 years; with interest, of course.
We are still facing huge budget deficits, with estimates ranging as high as $20 billion or more going forward, with no end in sight, and no expectation that revenues will improve to help cover the shortfall. 

The continuing ridiculous spending from the state government and the dire predictions of many, including our state controller, John Chiang, who stated last month that California will run out of cash by April 1st, provide the backdrop for an interesting investment challenge—what is a municipal bond investor in California to do?

I recently wrote an article about muni bond investing, in which I stated that, in general, state GOs (general obligation) bonds should be safer, all else being equal, than GOs and revenue bonds from county and city issuers, because the state has a larger taxing authority, and can support the payment of principal and interest through a broad-based, diversified taxing base.  But, given all of the challenges the state is facing and my own personal pessimism about the economy of the country and the state, I decided to take a closer look at our county and city bonds.

Santa Barbara county experienced an increase in revenues for our last fiscal year, which ended June30, 2009, of 3.2%, with total county revenues of $735 million.  Our total governmental funds increased $3.7 million, or 1.6%, to $243 million and our General Fund unreserved balance decreased $3.9 million, or 6%, to $57.9 million.  The General Fund balance is 25% of its annual expenditures and the General Fund unreserved fund balance is 17% of the total General Fund annual expenditures.  The Strategic Reserve designation, which is earmarked for severe economic downturns and emergencies, ended the year at $22.4 million.

Our expected budget for 2009/2010 is $747 million plus another $33 million for capital projects, for a total budget of $780 million.  This budget does not take into account various state cuts in funding that add-up to about $23 million, plus additional cuts are expected to CalWorks, In-Home Supportive Services, Child Welfare, and Foster Care that the County is not currently able to estimate at the local level.

I contacted Bernice James, our county Treasurer, to ask about the county’s outstanding debt and in particular their municipal bonds.  The county uses two basic types of financing—short-term and long-term.  For the short-term, which is used to fill the timing gap between when funds are needed for the budget and when property tax revenues are received, the county uses one-year notes that are sold to investors.  Our most recent round of these notes was sold at a yield of one-third of one percent. 

Our outstanding long-term debt related to general obligation and revenue bonds amounted to $84 million, a decrease of 8.5% from the prior year.  The County has $64.5 million in outstanding certificates of participation (COP) and has a rapid debt repayment plan that will reduce the debt by about 60% over the next ten years.  Our outstanding short-term borrowings, Tax and Revenue Anticipation Notes (TRAN), of $63.7 million were issued in July 2009.  Proceeds from the notes will be used to meet FY 09-10 cash flow requirements.

The County maintains a Standard & Poor’s “SP-1+” rating for short-term notes and both a Standard & Poor’s “AA+” and a Moody’s “A1” for long-term certificates of participation.  Standard & Poor’s in its October 7, 2008 credit profile raised its rating and underlying rating for Santa Barbara County’s appropriation debt from ‘AA’ to ‘AA+’.

Standard & Poor’s, in the June 2009 rating on the County’s Tax and Revenue Anticipation Notes (TRAN) for FY 09-10, states: “The [‘SP-1+’] rating reflects the County’s very strong underlying general credit characteristics,” as well as “strong projected debt coverage of 1.24x at maturity.”

The higher rating for our debt allows the county to issue notes and bonds with lower coupon rates, thus saving the county money on interest payments.  In contract, Standard & Poor’s recently lowered its rating on California GOs from A+ to A.  As you can see, our county bonds are significantly higher in rating than state GOs, so at least from the ratings agencies’ perspectives, our county paper is safer than that of the state.

We do have a projected $39 million deficit for our county budget, so all is not rosy.  Also, our unemployment rate for January was just reported at 10.4% up from a revised 9.5% in December.  The national labor rate has held firm at 9.7% for the past two months (seasonally adjusted), so this could indicate that we are lagging the country a bit, meaning that our unemployment rate may continue to rise, even after the country as a whole starts to improve.  Still, the county is certainly in better financial shape than the state. 

Treasurer James states that the county is planning one or more new bond issues shortly, and the details will be made available for interested investors.  There are three proposed projects—the Public Defender’s Office remodel, the Betteravia Expansion, and the Emergency Operation Center—with a total projected need for financing through Certificates of Participation of $16.1 million.  (For more information contact the county Treasurer’s office at (805) 568-2920.)

Bob Samario, Finance Director for the city of Santa Barbara, relates that S&P rated the city’s most recent airport bond AA-, and Moody’s rated it A1. This is a 5% coupon municipal (double tax-free for California residents) bond maturing in 2039.  (We have another airport bond outstanding, which matures in 2017, with a 4% coupon and the same ratings from both agencies.)  Total debt outstanding for the city is $208 million as of June 30, 2009, including the 2039, $47 million airport bond issue. 

So, as we can see, both the county and the city are receiving higher ratings than the state on their muni bonds.  While many of the state’s bonds have an implied AAA rating due to the insurance wrapper, we must be careful not to assume too much, since a default by the state would be catastrophic, and I would personally have doubts about the quality of the insurance, should a default occur. (I am not saying the state is going to default!)

I would still contend that, in general, state GOs would be a safer bet than individual city or county GOs or revenue bonds.  While I think the Federal government would step in and save the state, should the budget deficits overwhelm us, I would not be so confident about individual cities or counties that cannot pay their debts.  With that said though, one could possibly find a bit more safety and diversification by identifying county and city munis that are of high quality, to include our local county and city bonds.

As always, investors should consider their own, personal objectives and risk tolerance, and should consult with tax and financial advisors before making any investment decisions.  With that stated, if you are a muni bond investor, Santa Barbara might be a good place to look.

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