By Andrew Bary, “U.S. states represent one of the most secure areas of the global bond market, typically benefiting from low debt levels relative to the size of their economies, and the ability to cut spending and raise taxes during tough times. Even when hefty pension obligations and unfunded employee health-care liabilities are taken into account, state credit quality generally is strong. 

… “The most important factor about state credit quality is that states are sovereign entities that have the ability to raise revenues or cut spending as needed,” says Tom Kozlik, a municipal analyst at Janney Capital Markets in Philadelphia. There hasn’t been a state-government default since the Depression. 

… “While most state credits are stable and have improved in the past three years, a few have struggled. Illinois, New Jersey, and Connecticut aren’t fully funding their pension obligations, have thin financial reserves, are structurally imbalanced, and are using one-time revenue sources to balance budgets,” says Jim Evans, a portfolio manager at Eaton Vance, an investment manager with a specialty in municipal bonds.

… Fiscal trends generally have been positive. Nearly every state has enacted some pension reform since 2009 that either reduces benefits or increases employee contributions, and debt issuance has been light in the past two years. And laggards New York and California have shown improving finances and garnered rating upgrades.

… Barron’s has looked at state financial health for the past three years using data compiled by Eaton Vance. This year’s tally differs from last year’s because it offers a more comprehensive picture, based on about 10 measures that factor in assets, liabilities, and other gauges of economic health. The 2013 rankings were based only on the states’ debt and pension liabilities relative to their economic output. That approach had merit because it highlighted the growing pension burden in many states—an issue to which many investors have paid little attention. The broader approach taken by Eaton Vance this year offers a holistic look at state finances beyond debt and pension liabilities. …”

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