Should Muni Investors Take Note of California?

During the past decade, a turnaround in the Golden State has resulted in higher credit quality for many issuers.

Shortly after the 2008 credit crisis, a concern that we heard from many clients was, "Is the state of California likely to declare bankruptcy?" The answer was no for myriad reasons, but it illustrates the situation that the state's finances were in. That's no longer the case.

The turnaround in the Golden State has resulted in higher credit quality for many issuers in the state. As a result, we believe California municipal bond investors may want to consider a portfolio of all-California munis. And it isn't just California investors that should take note—because the state is the largest issuer of municipal bonds, so many mutual funds, exchange-traded funds (ETFs), or other investment options hold California municipal bonds. Here are a few things investors should know now:

1. The state has turned its financial position around since the 2007-2008 financial crisis. Following the 2008 financial crisis, the state's general obligation (GO) bonds were the lowest-rated of any state.1 Politically, the state needed a two-thirds majority to pass a budget, which led to cash-flow challenges. Additionally, the rainy-day fund was depleted and real estate construction and values in many areas experienced a dramatic bubble, then collapsed. Spreads—that is, the difference in yields, which are a measure of perceived risk—for a broad index of California muni bonds were higher than for other financially stressed states like New Jersey, Connecticut, and Illinois. At one point, spreads were close to those of bonds issued by Puerto Rico, which is now going through a major debt restructuring.

During the financial crisis, spreads for California bonds were elevated relative to other states