The longevity and severity of the recession have negatively impacted revenue streams - income, sales and property taxes - for municipalities, generally across the board. These are the primary sources of payment for portions of the municipal bond market. With many state and local municipal bond issuers facing substantial budget gaps, their financial strain is pronounced.
We recognize that in the current economic environment, many municipalities face difficult challenges. Tax increases, spending cuts or some combination of both will be required to balance budgets. We expect that most municipalities ultimately will succeed in addressing these fiscal difficulties, but a minority will not. Those that do not will be viewed negatively by the rating agencies. Therefore, we expect an increase in the level of bond issuer ratings downgrades. Prices of bonds can be significantly affected by credit concerns and/or rating agency actions.
Underfunded pension obligations and OPEB – other post employment benefit- obligations represent a significant challenge to municipal bond issuers in balancing their budgets. Pensions are incremental obligations, beyond normal operating expenses, that issuers must ultimately fund. If an issuer is 100% funded it means they have already set aside enough today to make payments on expected future pension obligations as they become due. If an issuer is underfunded, they will likely need to make additional dollar value contributions, reduce or delay benefits, or require increased contributions from employees - all changes that may be difficult to achieve. Some issuers face substantial challenges associated with Pension Obligations and OPEB – see more here.