As more people pick up municipal bond exchange traded funds gain fresh assets, investors should monitor their exposure to credit risk among states. For instance, Moody’s Investors Service recently sounded its concern over New Jersey’s burgeoning budget gap.
The Moody’s ratings agency warns that New Jersey could see a budget gap of $3 billion in the next fiscal year as the state struggles with rising costs and less-than-expected revenue, reports Elise Young for Bloomberg.
“Three consecutive years of revenue shortfalls, driven by optimistic assumptions and a lagging economic recovery, have created recurring mid-year budget gaps and will continue to pressure the budget,” Baye Larsen, a Moody’s senior analyst, wrote in a report.
The agency recently issued its sixth rating cut on New Jersey debt since Governor Chris Christie took office in 2010. Other major rating companies have also shown concern over recurring deficits due to falling revenue. Moody’s and Fitch have assigned New Jersey a negative outlook with further cuts possible.
“The downgrade to A1 reflects the weakened financial position resulting from recurring revenue shortfalls and ongoing reliance on non-recurring resources that have deferred structural imbalances into future years,” Moody’s Larsen said last week in a Bloomberg article.
The three ratings agencies have ranked New Jersey’s general-obligation debt at the fifth-highest, with its A1 rating tied with California and only above Illinois.
Many muni bond ETFs, such as the iShares S&P National AMT-Free Muni Bond ETF (NYSEArca: MUB) and Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM), are heavily allocated to general obligation (GO) bonds, or bonds that are backed by the credit and taxing ability of a city or state. GO bonds were the type of debt that got Detroit into trouble, now the largest U.S. munis bankruptcy on filing. [BlackRock: Detroit Bankruptcy Check-In: Will Lansing Extend a Lifeline?]
Looking at state municipality exposure, MUB’s portfolio include a large allocation toward California 22.6%, followed by New York 20.5%, Texas 8.6%, Illinois 5.6% and New Jersey 5.5%. The fund’s credit quality includes Moody’s rankings Aaa 8.9%, Aa 13.4%, Aa2 23.5%, Aa3 10.9%, A1 17.6%, A2 7.5%, A3 3.6% and Baa1 2.5%. [Despite Detroit Scare, Municipal Bond ETF Credit Risk Remains Muted]
ITM includes large exposures to New York 19.5% and California 13.5%, along with New Jersey 5.1% and Illinois 4.0%. The ETF’s credit quality breakdown includes AAA 15.6%, AA 57.5%, A 25.8% and BBB 2.2%.
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.