Morningstar Advisor - August/September 2012 - (Page 49)

Spotlight A Tale of Two Cities By Rachel Barkley and Elizabeth Foos An analysis of two obligors shows two municipalities at opposite ends of the credit spectrum. Municipal bonds, traditionally one of the safest investment asset classes, have provided a stable source of income for investors even in environments of economic volatility. But with the demise of the bond insurance industry, the undermined credibility of credit-rating agencies, and increased media attention on the funding shortfalls faced by state and local governments, investors have put a renewed focus on the underlying credit quality of municipal issuers and obligors of debt. The muni market is vast, with 1.5 million active bonds and more than 100,000 unique issuers, each of whom offers a variety of debt securities to the market. Assessing credit quality in the muni market can be difficult for investors because of the wide range of credit factors that influence obligors’ ability or willingness to repay their debt. Four Pillars opposite ends of the credit spectrum: Detroit, Mich., and San Antonio, Texas. Detroit has a pressured credit profile characterized by weak economic and demographic trends, limited financial liquidity, and very high debt levels. The city is under strict state oversight, and its ability to meet operating and debt obligations is questionable. Conversely, San Antonio has a strong credit profile with limited weaknesses and minimal risk exposure to bondholders. San Antonio’s local economy is diverse and remained resilient through the nation’s recent recession. Its strong management practices have allowed the city to keep its financial flexibility while continuing to provide healthy service levels. Economic Strength Detroit’s economic and demographic profile is extremely weak. Over the past decade, Detroit’s population has fallen by nearly 25%, bringing it to its lowest level since 1910. Although this means that the labor force has declined in number, unemployment rates remain exceptionally high. Wealth levels are low with roughly one third of its residents living below the poverty line. Local industries are diversifying somewhat, but the area economy continues to be dominated by the volatile auto industry. Financial Condition Morningstar approaches this problem by basing its municipal credit analysis on four pillars: economic strength, financial condition, debt and long-term-liabilities profile, and management and operating environment. Morningstar analysts then determine the overall credit quality of the issuer. To illustrate how widely the credit quality of local governments can vary, we have chosen two cities of similar populations that lie on When we look at a city’s economic strength, we analyze the size, diversity, and stability of the area economy. The property-tax base is a main factor for local governments, but we also examine demographic data, such as population and employment. San Antonio’s economy is strong and growing, anchored in military and government. The unemployment rate is below the national average. Wealth indexes are satisfactory, aided by a low cost of living and economic expansion. Bucking trends of the national housing correction, property values remain stable. Morningstar’s financial-condition pillar measures the issuer’s financial flexibility. For local governments, this includes consistency of operating results, reserve levels, revenue diversity and volatility, revenue and expenditure flexibility and liquidity levels. San Antonio’s financial picture has been strong with operating surpluses for each of the past five audited years and current reserves equal to more than 25% of total spending. The city’s major revenue sources are diverse and remained relatively stable in the recent recession. Restrictions on revenue increases are moderate and have not had any adverse effect on the city’s financial profile. Detroit’s financial position is very poor. It has a history of significant budget gaps because of a 49

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2012

Morningstar Advisor - August/September 2012
Letter From the Editor
How Much of the Behavior Gap Is Your Fault?
What’s Your View of the Muni-Bond Market?
A Balanced Life
How to Get to Know EMMA
A Strong, Robust Fund Business
Dividend Investing Abroad
Four Picks for the Present
Investment Briefs
Fund Expenses Through the Decades
Autos on Comeback Track
Lessons From the Muni-Bond Rebound
Municipal-Bond Landscape Shifts
Municipal Bonds 101
A Tale of Two Cities
Unraveling the Mysteries of Money
Small Companies Mean the World to Him
The Chinese Art Market and the Origin of Bubbles
The Myth of the Dumb Investor
Stocks That Can Stand the Heat
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The War on Savers

Morningstar Advisor - August/September 2012