City, Town, County, And State Municipal Bond Issuers Possessing Elevated Risk

by: Marc Gordon

This article is oriented toward those who buy individual city, town, county, and state municipal bonds with date certain maturities in the United States. There are many reasons for purchasing these bonds, and I will not delve into them here, since that is a subject for a different article. The genesis of this review was a series of articles in the Wall Street Journal (October 29, 30, 31, and November 2-3, 2013) that reviewed the state of financially troubled municipalities. This article will consolidate the information in those reports so that it is in a single place, and will add additional information and thoughts of my own. When it comes to municipal bonds I start from a simple premise, which is that I want individual municipal bonds to be in the "safe" money grouping where there is minimal risk to principal; for funds that are to be placed at risk, I would rather they be in the stock market with its potential for greater returns.

One of the difficulties of investing in individual bonds is knowing which to eschew because they have elevated risk for a future default, and which are likely to remain dollar good for the foreseeable future. A reasonable place to start an evaluation can be what grade the ratings services such as Moody's and Standard & Poor's assign to a bond issue, but as many investors discovered during the financial crisis, these services are not always reliable, so further analysis by an investor is required. An excellent source of information is the bond prospectus, which summarizes the main features of the bond and the financial condition of the issuing entity. There have been many issues from solid municipalities that upon reading the details of the offering in the prospectus have deserved to not be invested in, for reasons ranging from what exactly "guarantees" repayment of the bond to call dates to the viability of whatever the bond is funding. However, reading an entire prospectus is very time consuming. There are so many municipal bond issuers with superb financial management that it should be possible to create a list, as a first cut, of financially very weak municipalities which should be avoided, saving an investor the time required to investigate all bond issues originated by those entities. This is not to say that poorly managed municipalities never originate low risk bonds, it is simply a screening method to decrease the likelihood of buying a bond from a riskier issuer.

There are many reasons that a city, town, or county municipal bond issuer may have an elevated risk of default. I focus on five issues to winnow out some of the weakest hands.

  1. Recent Bankruptcy - Thankfully still rare, bankruptcy is the ultimate illustration of fiscal mismanagement. The following list includes the eight cities, towns, and counties that have gone bankrupt since 2010.
  2. Low Reserves - Some cities have had a negative general-fund balance in 2012. This means that their main source of funding had a net loss at the time the figure was reported. This indicates financial weakness.
  3. Miniscule Operating Fund - A city with a tiny operating fund in 2012, measured in days of cash on hand, may have trouble paying for services, maintenance, and other obligations, including bond payments, or it may need to dip into other funds or borrow money to pay current expenses.
  4. High Percentage of General Fund Spent On Pensions - Generous pension benefits can severely strain a municipal budget. If a city has a high percentage of its funds spent on pensions, then less money is available to pay for services, maintenance, and other obligations, including bond payments.
  5. Weak Tax Base - Cities that in 2012 had the lowest per capita value in real estate (indicating a very weak real estate market) may have difficulty raising revenue.

Below is the list of municipalities in alphabetical order that I consider to have a higher risk of default than is acceptable, followed by the primary rationale for this deduction. It may therefore be desirable to avoid these bond issuers.

Allentown, PA - Low reserves, Low operating funds, Weak tax base

  • Anaheim, CA - High percentage spent on pensions
  • Berkeley, CA - High percentage spent on pensions
  • Boise County, ID- Bankrupt
  • Buffalo, NY - Weak tax base
  • Brownsville TX - Weak tax base
  • Camden, NJ - Substantial state aid is required to keep Camden solvent
  • Central Falls, RI- Bankrupt
  • Charleston, SC - Low operating funds
  • Chicago, IL - Low operating funds
  • Detroit, MI - Bankrupt, Low reserves, Weak tax base
  • Fort Wayne, IN - Weak tax base
  • Fresno, CA - Low operating funds
  • Glendale AZ - Low reserves
  • Harrisburg, PA- Bankrupt
  • Hialeah, FL - Weak tax base
  • Hollywood, CA - High percentage spent on pensions
  • Independence, MO - Low operating funds
  • Jefferson County, GA- Bankrupt
  • Mammoth Lakes, CA- Bankrupt
  • New Orleans, LA - Low reserves, Low operating funds
  • Oakland, CA - High percentage spent on pensions
  • Pasadena, CA - High percentage spent on pensions
  • Philadelphia PA - Weak tax base
  • Providence, RI - Low reserves
  • Pomona, CA - Low operating funds
  • Provo, UT - Weak tax base
  • Rochester, NY - Weak tax base
  • Roseville, CA - High percentage spent on pensions
  • San Bernardino, CA- Bankrupt
  • San Jose, CA - High percentage spent on pensions
  • Shreveport, LA - Low operating funds
  • Springfield, IL - High percentage spent on pensions, Low operating funds
  • Stockton, CA- Bankrupt
  • Syracuse, NY - Weak tax base
  • Topeka, KS - Low operating funds
  • Torrance, CA - High percentage spent on pensions
  • Vallejo, CA - Bankrupt

Although states cannot legally declare bankruptcy, there are some that are much more poorly managed than the others. The most fiscally mismanaged states are potentially worthy of exclusion from a conservative bond portfolio, and include:

  • California (my home state)
  • Illinois
  • New Jersey
  • Michigan
  • Kentucky
  • Rhode Island
  • Arizona
  • Louisiana
  • Puerto Rico (not a state but a territory of the United States, and worth steering clear of)

This list is not meant to be comprehensive; there are certainly other criteria that could be used to identify other high risk issuers, but it does include many of the worst fiscally managed cities, towns, counties, and states in the United States. This article does not deal with utilities, water districts, hospital authorities, and the other numerous small special municipal districts that issue their own bonds within the municipal category. It is worth cautioning that these bond issuers must also be scrutinized; 30 such entities have gone bankrupt in the wake of the financial crisis (although 12 of these were from Omaha, NB).

In conclusion, the prudent municipal bond investor will always be aware of the issuer's general financial situation, and in particular should read the prospectus for the specific bond issue before purchasing any bonds. Individual bonds with date certain maturities can be excellent conservative investments, but to be such, higher risk municipalities should be avoided. Bond offerings from those cities, towns, counties, and states listed above should be approached with great caution, if at all.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.