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How rare are defaults in the municipal bond market?
During the most recent period, 2010-2011, there were only 11 defaults out of the 17,700 bond issues sampled, according to a report just released by Moody’s.
Although the average annual number of defaults (5.5) was up from the 2.7 yearly rate from 1970-2009, it remained extremely small.
In its report, which examined municipal bond defaults and recoveries from 1970 to 2011, Moody’s noted, “we expect municipal debt defaults will remain infrequent and isolated events, rather than systemic events, despite unprecedented credit pressure.”
90% of ratings were unchanged
The economic downturn has been the major factor in the increase in rating downgrades, though very few have ultimately resulted in actual defaults. Over the term of the study, 90% of Moody’s ratings went unchanged over any year-long period, illustrating the stability and resilience of municipal bonds.
Of the bonds that did default, the major cause, according to Moody’s, was “enterprise risk.” This risk results from a failure of a bond-financed project to achieve its projected results due to faulty planning or economic downturn, rendering a project unfeasible.
Closer scrutiny of the defaulted bonds showed the majority were in the healthcare and multi-family housing sectors. Only one general obligation issuer, out of the 9,700 rated by Moody’s, defaulted over the most recent three year period covered by the study.
The study also reinforced the notion that municipal bonds remain a safer alternative to corporate bonds. Over the 30-year time period analyzed, almost all municipal issuers were investment grade quality, with 94% earning an “A” or higher rating compared with 34% in the corporate debt market.
Furthermore, of municipals that did default, the ultimate recovery averaged 65% compared with the corporate rate of 49%. Moody’s found that “…municipal ratings were more stable, and defaulted…less frequently, than did their corporate counterparts.”
Naturally, going forward, Moody’s sees the greatest risk in communities that have suffered the most in the current economic downturn.
It should also be noted that cutting debt service payments in hard times does little to solve a community’s financial problems. Debt service tends to be a small budget item for most issuers, usually comprising only 5% to 7% of their budgets.
While headline-grabbing credits dominate the news, Moody’s study demonstrates once again that municipal bonds remain a stable investment compared to other volatile alternatives.
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