Own Muni Bonds? Don’t Panic : Experts Agree on That Advice, but No One Can Be Sure Yet What Prop. 218’s Effects Will Be
California’s huge municipal bond market is under a cloud of uncertainty thanks to last week’s passage of Proposition 218.
The measure puts new limits on local governments’ ability to raise money and allows some existing taxes to be called into question. The measure’s approval caused no immediate fallout in the muni bond market; prices stayed firm and trading continued as traders waited to see what legal challenges might emerge. No one knows for sure what the future damage might be.
The concern for investors, of course, is that the complex measure might cause some bonds to eventually lose value.
Specifically, some assessments and fees that in the past could be imposed by municipalities without voter approval now require that approval. In addition, the measure allows voters to call into question fees and assessments imposed in the last two years. This could hamper the ability of cities, counties and schools that sell bonds to raise revenue needed to finance current and future issues.
“Five years from now, if a city can never get another tax passed and a recession hits, it would make budgets tighter and make it harder to pay bonds back,” said Peter Bianchini, a director of bond-rating agency Standard & Poor’s Corp. “So if you are holding a general-obligation or lease bond from that city, you could see problems down the road.”
For the time being, there appears to be no immediate problem for specific California muni bonds. But bond specialists say only time will tell whether individual investors have time bombs ticking in their portfolios.
Proposition 218 is similar to Proposition 13, the landmark property-tax-cutting initiative approved by voters in 1978, in that it will take many years for its full effects to be felt.
The legislative analyst’s office has estimated it could cost local governments $100 million a year short-term in lost revenues; some bond analysts predict triple that. Several cities, including Los Angeles, are considering filing legal challenges to the initiative.
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Bond experts stress that investors should not begin any panicked selling of certain types of California bonds, because any problems with existing bonds should be few and far between.
If you are worried about your securities, look closely at the bond documents to see which types of bonds you own. Bonds reliant on revenue that hasn’t been approved by voters could be candidates for trouble, although it’s expected that the outcomes of legal challenges to the measure will determine whether that will be the case.
“We think very, very few bonds will be directly affected because very few bonds will have the revenue sources that back them suddenly eliminated by future voter challenges,” said David Brodsly, an analyst with Moody’s Investors Service, a rating agency. “It’s going to take a lot of time to sort out how this impacts investors.”
Keep in mind that the measure prohibits the use of special assessments for general services such as fire or police, although some such assessments are already securing bond issues for fire or police service and equipment.
The measure also gives voters the right to repeal certain existing taxes, some of which may be backing your bonds. But experts say it is unclear whether voters can legally undo taxes that are already backing bond issues.
“There is a shadow here, but it is not clear,” said Zane Mann, publisher of the California Municipal Bond Advisor newsletter. “I don’t see this measure as an immediate problem for investors. The courts will need to decide.”
Here are some of the types of securities that might be affected over the long term:
* Assessment district bonds. If the bonds were sold after January 1995 and are backed by assessments that did not get majority voter approval, they could be at risk.
For example, Mann said, development bonds that were sold to fund infrastructure in the first phase of a project that is dependent on a second phase of bonds being sold could be headed for trouble. That would be the case if the second-phase bonds cannot be sold because the assessments earmarked to pay off the first-phase bonds do not get a majority voter approval.
* Lease revenue bonds or certificates of participation sold by charter cities throughout the state. In Los Angeles County, charter cities include Downey, Los Angeles, Burbank and Santa Monica. These cities were allowed to raise various types of revenues without voter approval and use money from the general fund to secure millions of dollars of bonds. Bonds secured by taxes whose proceeds go to the general fund, such as those on hotel occupancy and business licenses, might be at risk if it is harder for cities to raise these taxes in the future.
There are a lot of ifs here. But one thing is certain: The amounts involved in these types of bonds are large--according to Moody’s, more than $14 billion of lease bonds sold by charter cities are still outstanding. However, not one of these bond issues has been identified as a problem yet, analysts said.
The amount of assessment bonds sold since 1985 totals more than $7 billion, although some of those bonds have already been redeemed, according to data from the California Debt Advisory Commission, a state agency that tracks bond issuance.
There is currently about $130 billion in California municipal bonds outstanding, including debt sold by the state and other local governments and entities. The national municipal bond market totals $1.3 trillion.
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If you are a bond investor and think you might own the types of bonds mentioned above, check with the underwriter that sold them or lawyers who worked on the deal to find out the status of your holdings.
Major rating agencies such as S&P; and Moody’s will also monitor individual issues. Contact rating executives at their San Francisco or New York offices to see if credit concerns about your bond have prompted rating downgrades. At Standard & Poor’s, the number for the rating desk is (212) 208-1527; at Moody’s, it’s (415) 274-1718.
“We will certainly do our best to provide any write-ups we have,” S&P;’s Bianchini said.
You have little to worry about if your California municipal bond carries some type of bond insurance. Credit enhancements such as insurance or a letter of credit from a bank ensure that principal and interest on your bond will be paid, even if the issue defaults.
Above all, experts said, don’t panic and try to sell your bonds in a hurry. There are dealers and brokers who will try to take advantage of your fears. They will offer to buy your certificates of participation or land-backed bonds, which are often higher-yielding than other bonds, for just cents on the dollar.
That happened in the months after the Orange County bankruptcy filing, when many investors engaged in panicked selling and let their bonds go for too little. Those bonds were eventually paid back in full with extra interest.
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If you don’t own individual bonds but rather are investing in munis through mutual bond funds, you can still determine the holdings of your bond funds by calling the fund.
Most bond funds that own only California bonds are still trying to figure out their strategies.
Top money managers at Twentieth Century’s Benham Group in Mountain View, Calif., convened a meeting early last Wednesday after the measure passed to determine their strategy. Other major muni fund groups, such as Franklin, are also monitoring the situation.
“Indirectly it could have an impact on bonds we buy, but right now we’re looking to see if there is any impact on the bonds we own; if there is, we think it will be minimal,” said Dave MacEwen, manager of $2 billion of municipals for Benham Group, which, along with Twentieth Century, will become American Century Investments in January.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
California Municipal Bonds
T. Rowe Price & Associates tracks the yields of 20 California municipal bonds and the Bond Buyer Index of 40 national issues.
Bond Buyer 40-bond Index
November 1996: 5.79%
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California Index
November 1996: 5.67%
Five widely held California bonds:
Issue: California general obligation 10-year
Coupon: (generic)
Maturity: (generic)
11/1 Yield: 4.95%
Friday Yield: 4.90%
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Issue: California general obligation 20-year
Coupon: (generic)
Maturity: (generic)
11/1 Yield: 5.60
Friday Yield: 5.57
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Issue: Los Angeles Metropolitan Transit Authority (insured)
Coupon: 5.00%
Maturity: 7/1/2017
11/1 Yield: 5.68
Friday Yield: 5.65
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Issue: California public works lease revenue
Coupon: 6.00%
Maturity: 10/1/2014
11/1 Yield: 5.70
Friday Yield: 5.70
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Issue: San Francisco airport (insured)
Coupon: 5.65%
Maturity: 5/1/2024
11/1 Yield: 5.75
Friday Yield: 5.70
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Source: T. Rowe Price & Associates in Baltimore, which manages a $150-million California bond fund.
Note: All yields are as of 2 p.m. Friday. Yields are based on institutional trading, retail prices and a survey of California brokers. Yields offered to individual investors will vary.
