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Citigroup recommends buying low-rated state bonds

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Illinois

* This isn’t as silly as some might think. As the article rightly notes, no state has defaulted on its bonds since Arkansas during the Great Depression and states can’t file for bankruptcy…

For a year, Citigroup Inc. has recommended a strategy that has been controversial among its clients: Buy debt issued by the lowest-rated U.S. states to boost returns in a market where tax-exempt yields sank to historic lows.

Though there is “little optimism” that some of the worst-rated states with negative credit outlooks will see their funding of public pensions improve enough to help their bond ratings, Citigroup continues to “cautiously” recommend the debt to investors, according to a new report.

“It’s a controversial topic, but we think it is a compelling buy,” Vikram Rai, head of municipal strategy at Citigroup, said in a phone interview. “There is downgrade risk, but the credit stress is going to unfold slowly. The spread is compelling.”

Citigroup’s report declines to name specific states but some of the lowest rated such as Illinois and New Jersey, have returned 5.148 percent and 6.067 percent this year, respectively, according to S&P Municipal Bond Indices, some of the highest in the market.

posted by Rich Miller
Wednesday, Sep 14, 16 @ 9:53 am

Comments

Makes sense, states pay their bond debt like clock work and the return is good.

Kind of undermines the credibility of the bond rating agency “downgrades” doesn’t it? Especially if wall street likes the relative safety of the investment.

Comment by JS Mill Wednesday, Sep 14, 16 @ 9:58 am
States can’t file for bankruptcy… yet. Governor Rauner appears to be doing everything he can to create a case to challenge that long-standing rule.

Comment by aunt_petunia Wednesday, Sep 14, 16 @ 10:05 am
So, Illinois can comfortably become an even bigger financial mess in order to further elongate the spreads for investors! What a deft financial plan! /s

Comment by Deft Wing Wednesday, Sep 14, 16 @ 10:06 am
I’ve been telling people for awhile that this is Rauner’s true end game. Set the place on fire and then show up for the fire sale.

Comment by Dome Gnome Wednesday, Sep 14, 16 @ 10:08 am
Yes. Ratings agencies still not quite over their fever from the big one. What Wordslinger’s been saying for years.

Comment by walker Wednesday, Sep 14, 16 @ 10:09 am
If the bond rate of return is over 5%, why doesn’t the state offer a non bankruptcy CD type package to the average investor. Local CDs by me are .3% for one year. Do this through the local banks. Let the bank keep 1% and give me 4%. The state is going to pay 5% anyhow why not get some of that back to me.

Comment by zatoichi Wednesday, Sep 14, 16 @ 10:14 am
And let’s not forget that, after the 1933 default on bond payments, Arkansas did eventually and mostly pay off those bonds. Yes, there was about a decade of uncertainty and refinancing activity, and yes, the Federal government did provide a bailout of sorts in 1943 through the RFC. It took until 1972 or so for some of the refinanced bonds to get paid off … but the debt holders, including the Federal government, did OK.

If you want all the details, bondbuyer has a couple of articles on the 1933 Arkansas bond default.

Comment by RNUG Wednesday, Sep 14, 16 @ 10:18 am
Even if a president and Congress could agree to amend the federal bankruptcy code to allow states to file, it’s highly questionable whether such a law would pass Constitutional muster under the contracts clause, Article 1, Section 10.

Comment by Anonymous Wednesday, Sep 14, 16 @ 10:18 am
I follow the logic as part of a large and diversified portfolio. I do think there is some confusion about the inability of states to file bankruptcy. As commentators here have said, there is no provision in the Federal Code for States to file for protection from creditors under the Bankruptcy laws. My understanding is that Sovereign Default is covered by precedent under Common Law. Before the last “temporary” tax increase was passed I talked to CMS lawyers who were researching Indiana’s default in the 1800’s following overbuilding of canals with State guarantees.
One of the reasons for Indiana’s strong fiscal condition is the extremely strong constraints on State borrowing. Constraints built into their Constitution after the financial probems hit.

Comment by Last Bull Moose Wednesday, Sep 14, 16 @ 10:18 am
Was at a school board meeting a while back and their financial guy suggested parking some money in state bonds and pointed all of that out.

The school board was still uncomfortable with the risk and took a pass.

Comment by Oneman Wednesday, Sep 14, 16 @ 10:41 am
How long until Bruce calls them and demands that they stop suggesting people should invest in Illinois?

Remember that time when our own governor trashed the CIty’s bond sale? Talk about a backhanded tax increase.

Comment by siriusly Wednesday, Sep 14, 16 @ 10:43 am
== talked to CMS lawyers who were researching Indiana’s default in the 1800’s … ==

- Last Bull Moose - , that is one of the scariest comments I have read in a while. Presumably they were ordered to do it. Really gives an insight into the mindset of the Governor as to the State honoring its’ obligations.

Comment by RNUG Wednesday, Sep 14, 16 @ 10:53 am
- Oneman -

I can see taking a pass on parking money there short term; might be a issue trying to sell, especially if the Federal Reserve starts raising rates.

Long term as part of a diversified portfolio, they make sense.

Comment by RNUG Wednesday, Sep 14, 16 @ 10:56 am
Two words: Puerto Frickin’ Rico.

Comment by Juan Epstein Wednesday, Sep 14, 16 @ 11:34 am
== Two words: Puerto Frickin’ Rico. ==

1) early indications are the pensions will mostly be protected and the bondholders will get the short end of it

2) Arkansas (1933-1943) could actually be a template for working out a restructuring / bailout.

Comment by RNUG Wednesday, Sep 14, 16 @ 11:43 am
“Two words: Puerto Frickin’ Rico.”

Puerto Rico
Population: 3.5 million people
Median household income: $19k
GDP: $131.9 billion

Illinois
Population: 12.9 million people
Median household income: $54k
GDP: $771.9 billion

– MrJM

Comment by @MisterJayEm Wednesday, Sep 14, 16 @ 12:03 pm
RNUG, This was under Quinn, who clearly did not want to default. Cash flow was so tight that DCFS was unable to print documents for Court cases. The vendor was not willing to provide toner for printers and copiers.

Ever an optimist, I hope the legal work helped persuade people that the tax increase was needed and there was no other way out. Maybe the current crew needs to revisit the problems with sovereign default. It is still scaring Indiana more than 150 years later.

Comment by Last Bull Moose Wednesday, Sep 14, 16 @ 12:19 pm
Where is Wordslinger?

Comment by anon Wednesday, Sep 14, 16 @ 1:00 pm
Puerto Rico: Debt to GDP 68%
Illinois: Debt to GDP 9%

Comment by Liberty Wednesday, Sep 14, 16 @ 1:26 pm
I guess Rauner doesn’t consider spending payroll researching dubious legal strategies as waste.

Comment by Ret Professor Wednesday, Sep 14, 16 @ 1:45 pm
- Last Bull Moose -

Thanks for the clarification; from the phrasing, I thought it was more recent.

Comment by RNUG Wednesday, Sep 14, 16 @ 1:54 pm
RNUG, Sorry for the confusion.

Sovereign Default is not totally uncharted territory, but all the maps are very old and the landscape has changed.

Comment by Last Bull Moose Wednesday, Sep 14, 16 @ 2:21 pm
== Sovereign Default is not totally uncharted territory, but all the maps are very old and the landscape has changed. ==

Yeah, today some groups think government should no longer honor its obligations and debts if it means those groups have to pay a bit more.

If there is a lesson here, it is that Arkansas took 30 years to dig all the way out of their hole. That’s about the same length of time it will take to dig out of Illinois’ pension funding mess … assuming they stay the course of the Edgar Ramp.

Comment by RNUG Wednesday, Sep 14, 16 @ 3:07 pm
Arkansas had about $160M in bond obligations in 1933. That’s about $3B in today’s dollars, or less than 3% of what Illinois’ pension liability alone. Small potatoes by Illinois standards.

Not sure we should be using states samples from the WWII era as our models for recovery.

Comment by City Zen Wednesday, Sep 14, 16 @ 5:40 pm
“Arkansas had about $160M in bond obligations in 1933. That’s about $3B in today’s dollars, or less than 3% of what Illinois’ pension liability alone. Small potatoes by Illinois standards.”

In 1932 only 62.7% of Arkansas’s labor force was employed. The current Illinois unemployment rate is 6%.

In 1931-32, Arkansas had $17.5 million in tax revenue. Adjusted for inflation, that would be $302.4 million in 2014 dollars.

Illinois total state tax collections in 2014 were $39.2 billion.

That’s billion with a ‘B’.

Illinois has problems, but Illinois’ problems are nothing like Arkansas in 1933.

– MrJM

Comment by @MisterJayEm Wednesday, Sep 14, 16 @ 6:48 pm