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Q

I am 61 years old and have a large portion of my retirement portfolio in general obligation Arizona muni bonds. I am concerned about potential defaults due to the budget crisis in Arizona.  Most of my bonds are school bonds. Do you have any suggestions?

A

James A. Klotz responds:

In its most recent review of Arizona’s GO rating, Standard & Poor’s noted: “In accordance with the Arizona Constitution, the state cannot issue general obligation (GO) bonds. Therefore, the state has historically issued sales tax-, gas tax-, and appropriation-backed debt.” Nevertheless, S&P has an “AA” rating with Negative Outlook on the state, reflecting a growing budget gap and lack of agreement on a solution.

School district bonds are generally secured solely by the districts. There is no doubt that most districts are experiencing financial pressures similar to the state itself. With that in mind, however, we still believe that bonds issued as general obligations will be paid before other obligations, as is indicated by the GO pledge.

It is rare to hear budgetary discussions include talk of not paying bonded debt. While this is always possible, we do not see school districts with ratings of “A” or above being in danger of missing debt service payments. “BBB” category general obligations are expected to meet debt service obligations as well, but tend to have thinner financial reserves, less financial flexibility to raise revenues and weaker economies.

You may want to consider diversifying your portfolio so that you are not overly reliant on any one municipal bond sector. In any case, we still rely on more than 100 years of history that has seen municipal bonds maintain one of the strongest records for repayment of any investment asset class. Although times are tough, we still believe bondholders of “essential” public service bonds can expect to receive the interest and principal payments that they are entitled to.