A good portion of new home sales growth in recent years may have been fueled by a fair amount of subprime loans. Builders were able to sell homes to people with marginal financial flexibility and/or credit scores. Rising new home prices fueled growth in assessed values, helping to keep local governmental coffers well-funded.

But clearly, that cycle has come to an end, resulting in more unsold homes, lower property and assessed values.

The subprime mortgage crisis began making headlines roughly one year ago. Since then, its implications have now crossed not only geographic borders, but into the financial markets as well. “The lingering after-effect is worse than any market hangover we would have expected,” says Mike Ross, a municipal desk analyst with Morgan Keegan & Co.

We recently spoke with Mike, who explained the implications of the mortgage crisis on the municipal marketplace.

MuniNet: How does the housing market impact municipal bond credit quality?

Ross: The mortgage crisis is exerting a great deal of pressure on assessed values. In many areas of the country, the real estate slump has resulted in lower assessed values, leaving many communities faced with the challenge of declining property tax collections, and therefore, reduced revenues.

Most elected officials – especially those interested in seeking re-election – are wary of raising millage (tax rates). When assessed values are increasing and tax revenues show a parallel upward trend, then not raising rates can be a prudent political strategy. Conversely, when assessed values fall and millage stays the same, it translates into a decline in property tax revenues, stressing the community’s financial condition.

MuniNet: What about other revenue sources – like sales or utility taxes?

Ross: Because sales tax is a function of disposable income, revenues will naturally decline in a stressed economy – local or national in scope. With less money to spend, consumers are forced to make more careful choices. For example, because of rising gas prices, recent figures indicate that many people are spending a larger percentage of their discretionary income on gas – and therefore have less to spend on non-essential items, whether a new pair of expensive jeans, a high-end television set, etc. People will still spend money, but may be more frugal in their choices, buying fewer or lower priced items. Likewise, while people will still spend money on telephone services, gas, and electric, they will tend to be more careful in their consumption, impacting utility tax collections as well.

MuniNet: Where can municipalities make up the lost revenues?

Ross: They really can’t. In these types of situations, municipalities face tough choices in terms of what programs and services to cut from their budgets. Some may look to eliminate “non-essential” programs or community services. Others may resort to staffing cuts, or replacing older employees with younger candidates, who may be less experienced and command a lower salary.

MuniNet: Just how bad is the subprime mortgage crisis?

Ross: There are so many variables involved in quantifying losses from subprime mortgages that early estimates have been futile. And efforts to quantify losses have only heightened levels of uncertainty, particularly for investors. The problem is, we don’t really know when the trend is going to hit bottom.

MuniNet: Have any types of mortgages more problematic than others?

Ross: Subprime adjustable rate mortgages – or ARMs- have been the area of most concern because foreclosure rates have been highest in this mortgage sector. We believe that by the end of 2008, we will have moved through the worst of the subprime ARM resets.

MuniNet: How will foreclosure activity affect property values and tax?

Ross: The losses that many lenders are experiencing as a result of foreclosure – estimated between 20 cents to 60 cents on the dollar – raise concerns because lower property values, and subsequently, lower assessed values, would then negatively impact tax collections.

MuniNet: Which areas of the country are experiencing greater foreclosure rates?

Ross: According to a July 2008 report released by RealtyTrac, Nevada took had the highest rate of foreclosures during the second quarter of 2008, followed by California and Arizona, respectively, in second and third place. Metro areas in California and Florida comprised 16 of the 20 markets with the highest foreclosure rates. With one in 25 properties receiving a foreclosure filing during the quarter, Stockton, California had the highest rate of any metro area in the country. Other metro areas among the top 20 include Las Vegas, Fort Lauderdale, Phoenix, Detroit, and Miami.

MuniNet: What’s your overall prognosis?

Ross: Attention has been focused on certain states and metro areas that are facing (or are expected to face) significant challenges in their real estate markets, including higher rates of foreclosure. More than 40 million homeowners may see their property values and municipal tax bases drop by as much as $356 billion over the next two years. But the vast majority of these foreclosures will take place in a limited number of states and metro areas.

Municipalities in several states – including Vermont, South Dakota, Montana, and Wyoming, for example – are much better poised to maintain their local property tax base. The twenty states at the bottom of the rankings in terms of foreclosure rates – i.e., those with the lowest concentration of foreclosures – comprise only one percent of the nation’s gross foreclosure numbers.

The prognosis, therefore, is mixed. While a national crisis is unlikely, we will be more apt to see problems of a more dramatic nature limited to a dozen or so states with the highest concentration of foreclosure rates.


Mike has over twenty-five years of professional experience in fixed income research and credit analysis.

Through the years, his research has appeared in several financial publications, including The Bond Buyer and Smith’s Research & Gradings.

He has worked in credit research and related fixed income departments of several broker/dealer and institutional investment firms.

Prior to joining the Municipal Credit and Strategies Group as a Senior Vice President at Morgan Keegan & Co. in April of 2007, Mike teamed with other professionals to launch the Lord Abbett Municipal High Yield Fund. He was the Managing Director of Municipal Research for RBC Dain Rauscher for nine years before that.

He is a graduate of Roosevelt University (1981) and attended the graduate program of the University of Texas at San Antonio. Mike received his Charter Financial Analyst (CFA) designation in 1993.