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By Jeremy Glaser | 02-22-2013 03:00 PM

Muni Market Greatly Improved, but Do Your Homework

The muni market has seen a strong recovery since 2009, though these tax-advantaged products are much safer in some regions than others, says Morningstar's Jeff Westergaard.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many investors, worried about tax efficiency have been keeping a close eye in the municipal-bond market. I'm here today with Jeff Westergaard; he's Morningstar's director of Municipal Analytics. We're going to get his take on the credit quality in the muni space and also if muni bonds look attractive compared with other fixed-income asset classes?

Jeff, thanks for joining me today.

Jeff Westergaard: You bet. Thanks for having me.

Glaser: Let's take a look at just the general credit landscape for municipals. A few years ago, there were some highly publicized reports about the coming flood of municipal bankruptcies and that this asset class was potentially very unsafe. What's happened of that? Where do you see the state of the credit market right now?

Westergaard: We don't want to overlook the fact that the recession of 2007, 2008, 2009 was really the worst economic period that the country has faced since the Great Depression, and that certainly had a severe impact on the fiscal health of municipal government issuers. But the fears of the municipal market being the next shoe to drop and apocalyptic bankruptcies and defaults simply have not proved to be true. In our opinion, Morningstar believes strongly they will not prove to be true. In fact, if you look at the fiscal health, particularly at the state level of government issuers, it's improved tremendously since the low point of the recession in 2009.

Glaser: Let's take a look at across on these different issues and different bond types. Are there some that seemed to be better-positioned from a credit perspective than others?

Westergaard: Well, yes. We really think that if you focus on the state-level issuers as opposed to local governments within those states, states tend to have some very significant advantages, particularly in terms of financial flexibility and what they can and cannot do, particularly on the revenue side. For local governments within a state, oftentimes they are dependent on the state government for transfers of funds, et cetera, and plus they are generally much smaller entities than a state is.

So, states have a leg up, if you will, over local governments just due to both size and the legal structure the way that state governments determine what local governments can do.

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