U.S. municipal governments, facing more than $100 billion in budget deficits this year as federal economic-stimulus funds wind down, will weather lower demand for debt and higher borrowing costs, Moody’s Investors Service said.
No states rated by Moody’s will default this year, while a few local governments may miss payments, the New York-based company said today in a report. Few U.S. municipal governments borrow to fund short-term operating needs, Moody’s said.
“Most municipal debt is used to finance capital projects, and governments have the ability to defer projects if they cannot finance them at rates that make sense,” said Naomi Richman, a Moody’s analyst. “Even many issuers of short-term cash-flow notes could draw down their available cash reserves.”
The $2.86 trillion municipal bond market has been buffeted in the past three months by predictions of defaults and a rush to issue federally subsidized Build America Bonds before the program ended Dec. 31. Last month, Meredith Whitney, a banking analyst, said she expected 50 to 100 “significant” municipal- bond defaults this year totaling “hundreds of billions.”
Whitney, who correctly predicted a Citigroup Inc. dividend cut in 2008, has written a 600-page report on the financial health of the 15 largest states, which hasn’t been made public. She is seeking government permission to start a firm to compete with Moody’s and Standard & Poor’s, saying both companies lost credibility after they gave top ratings to mortgage-backed securities that were later cut to below investment grade.
In a study last year, Moody’s said 54 municipal issues it rated from 1970 to 2009 defaulted. Only three were general governmental defaults. In 2010, $2.52 billion of municipal bonds defaulted, compared with $14.5 billion of corporate bonds, according to the Distressed Debt Securities Newsletter. There were no defaults in 2010 by state or local governments rated by Moody’s, the company said.
To be sure, some of the biggest states, such as California and Illinois, that have relied on borrowing to finance deficits or issued short-term notes to pay bills before tax revenue rolls in, face the greatest fiscal stress.
In addition, municipalities that issue floating-rate bonds and use bank credit facilities to ensure investors can redeem the debt face higher costs because of rules requiring banks to hold more capital to absorb unexpected loses.
Municipal debt is fully amortizing, with both interest and principal payments included in operating budgets, and issuers aim to achieve level or declining debt service, according to Moody’s and Citigroup reports. Corporations and nations such as Greece that borrow money that must be paid in one lump sum when the debt comes due may be more vulnerable to rapid shifts in market sentiment.
Greece had to negotiate a rescue package from the International Monetary Fund because principal and interest payments coming due were more than 25 percent of its annual receipts, according to a report by Citigroup on municipal rollover risk.
Debt service is a relatively small portion of most government budgets, Moody’s said.
Battered budgets and a $30.6 billion flood of supply weren’t the only reasons, Moody’s said.
The extension of George W. Bush-era tax cuts reduced the value of holding tax-exempt municipal bonds and made other assets, such as stocks, more attractive.
“Despite reports of a loss of investor confidence in municipal bonds, credit risk is only one of several factors driving investor decisions about holding municipal bonds,” Moody’s said.
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