11/07/2018

The Essential Municipal Bond Market

by

Anthony Tanner, CFA®, Senior Vice President and Portfolio Manager, Aquila Tax-Free Trust of Arizona

Seldom in the financial landscape do investors have greater ability to support and participate in their local and state economy than through investing in municipal bonds. Municipal bonds can offer individual investors a source of income that is generally exempt from Federal and state income taxes.

The municipal bond market provides more than just an avenue for investors to earn tax-free income.   At the local level, it is a vital and core component of economic development.  Municipal bonds are the primary tool by which state and local governments implement public policy through spending on infrastructure projects, such as hospitals, schools, water and sewer systems, airports and other vital transportation projects.   Many of our region’s most visible and successful public works projects have been funded primarily through municipal bonds, including the Light Rail System, the Sky Harbor Airport expansion, and Arizona State University campus development.

In Arizona, our residents benefit from a dynamic and resilient local municipal bond market, as illustrated by the manner in which state and local governments weathered the great recession in 2007-2009. By the low point in that economic downturn, the Arizona economy had shed nearly 300,000 jobs as employment declined 11%, compared to 6% nationally.   Nevada was the only state with a deeper decline.  Throughout that time, Arizona’s credit rating declined minimally from an average of AA- to A+.

Arizona set a recent record for employment after surpassing its pre-recession peak in 2016, and its current credit ratings of AA by S&P and Aa2 by Moody’s1 are actually higher than prior to the outset of the recession.

Education bonds in Arizona provide an illustration, with Arizona school districts receiving improved ratings from the statistical rating organizations.1   A budget agreement reached by the state in May, 2018 implemented policies that increased revenues and strengthened school budgets.  Rating agencies have expressed a positive outlook regarding these changes, which follow recent improvement in the credit quality of Arizona school districts.  Since June, 2017, S&P has raised its credit rating on ten Arizona school districts while modestly downgrading two school districts.  Of the 64 Arizona school districts S&P currently rates, 75% carry an A- to A+ rating, while 25% are rated AA- to AA.

The Arizona municipal bond market is also very diverse and fragmented.  As of June, 2017 nearly 900 separate municipal entities in Arizona reported combined outstanding long-term debt of $36.4 billion. While these figures indicate the scale of the Arizona municipal bond market, many small, infrequent issuers are represented in the totals.  Nationally, the municipal bond market represents nearly $3.9 trillion in outstanding market value, and more than one million individual bonds issued by over 50,000 distinct issuers, including states, state government agencies, large municipalities, and small towns.

Rather than trading on a centralized exchange, municipal bonds are traded “over the counter” among more than 1,300 registered dealers, with the top 20 dealers executing approximately 70% of the trading volume.  The complexity of the municipal bond market makes it beneficial for some individuals to take advantage of one or more professionally managed investment vehicles.   It also explains the various means by which municipal bond are currently owned, reflecting the increased diversification that can be achieved by complementing individual bond holdings with professionally managed portfolios.

Individual investors comprise the largest category of municipal bond owners.  Many hold bonds directly, while over 33% of the amount invested by individuals in municipal bonds is held in professionally managed mutual funds, closed-end funds and exchange traded funds.  Banks, with 15%, and insurance companies, with 13%, are also primary owners of municipal bonds.

When Arizona investors consider the high quality and demonstrated strength of the Arizona municipal bond market, these characteristics can provide them with added confidence in making municipal bond investments that are essential to furthering the economy and quality of life in Arizona.

1 Independent rating services (such as Standard & Poor’s, Moody’s and Fitch) assign ratings, which generally range from AAA (highest) to D (lowest), to indicate the credit worthiness of bonds.

Shares of the Funds may only be sold by offering the Funds’ Prospectus. Before investing in a Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus.  The prospectus is available from your financial advisor, and when you call 800-437-1020 or visit www.aquilafunds.com.