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Deep Research Key in Stormy Muni Market

Miriam Sjoblom, CFA

Miriam Sjoblom: Hi, I'm Miriam Sjoblom, a mutual fund analyst at Morningstar. I'm here at the Morningstar Investment Conference with Hugh McGuirk, who is head of the municipal bond team at T. Rowe Price. Thanks for joining us.

Hugh McGuirk: Thank you, Miriam.

Sjoblom: To start out, we talked in our panel today about just the really dramatic changes that have happened in the municipal bond market. I think one the big things that happened over the past year was that investors had gotten used to relying on some crutches like bond insurance or rating agency ratings in picking their bonds. I think what stands out about your approach is that you never relied on those type of things. You've always done your own research and that's kind of the cornerstone of your approach. I'd be interested in hearing more about that process.

McGuirk: Sure, Miriam. Thank you. We have always looked through to the underlying issuer. We have never relied on the mono-line insurers for their guarantee. As such, I think the market environment for '08, when the mono-line insurers had some difficulties, I think that helped us out a little bit relative to others, when maybe they were more reliant on insurance, rather than looking through the underlying. You asked about the credit market environment and all too. If you look at the muni market as a whole, five years ago it was a very benign credit environment. 85% of our market--if you look at the Lehman index, now Barclay's index--it was AAA or AA. Today it's around 60%.

So the overall measured credit quality of our market has declined, and that's made it some much more important to have good research to make sure that we're making the right investments in this challenging market.

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Sjoblom: I'd be interested in hearing, too, maybe when just a few areas are feeling some economic pressure and stress, it's a lot easier for analysts to prioritize what they're investigating. A time like this, where the pain is so widespread from issuer to issuer, I'd be interested in hearing about how the analysts adapt to this environment and what their process is like. What things are they taking a close look at?

McGuirk: The immediate credit environment, as I mentioned before, is certainly more of a challenge today than it has been in the past. But that's true of every credit environment. So we're not unique in that regard. I think our analysts are making sure that we're focusing on finding reliable revenue streams and making sure they're doing stress tests analysis to make sure they understand what if there were an impact, let's say on income tax receipts or sales tax receipts in certain states. Then how would that affect the overall quality of the state? What would that mean in terms of their need of financing going forward?

So by doing this type of analysis, this stress test and such--which is an exercise we just went through recently--I think we're doing a better job in figuring out where to spend out money around the country.

Sjoblom: Are there any themes that have emerged over this period about where you guys are concentrating? Where you're finding the best opportunities today?

McGuirk: Sure. We've always had a little bit of a tilt towards revenue bonds. Relying on our research to pick up a little bit of incremental yield in the revenue sector compared to the general obligation sector. But I think at this time in particular, that's definitely the case. We are worried about the declines in tax receipts in localities and for states. And so we're keeping it underweight in general in obligations, and we're focused even more so on revenue bonds. And in particular on those revenue bonds that are so-called essential service. Let's say a water/sewer bond or a utility revenue bond, with has a little bit more reliable and predictable revenue stream compared to, let's say the tax receipts at a particular state.

Sjoblom: I guess one question--it's maybe not the most positive question. As an investor, given the extremes we've seen and the extreme losses last year, at this point in the game, what is it that you're most concerned about going forward.

McGuirk: That's a tough question. Frankly, it's a tough economy. And if the economy continues in this state for the next two years or some period beyond... I think most people expect the economy to recover in six to 12 months. It would concern me, and that's the kind of thing I would worry about, if the economy stays in the ditch for the next two years as opposed to just the next six months or 12 months. That would mean a lot more stress on the credit markets overall, and the muni market in particular. Stress on tax receipts, income tax receipts, higher unemployment. It would make for a much more challenging credit environment.

But again, what makes me feel better about that is we have a pretty strong credit research team that's following what we own, following the market for us. So that we can make sure we're on top of the issues that are facing our issuer credits.

Sjoblom: Thanks very much for taking the time.

McGuirk: Thank you very much, Miriam. I appreciate it.