Municipal-Bond Defaults May Beat Record High in 2011, Richard Lehmann Says

Municipal-bond defaults, including bankruptcies and the use of reserve funds for payments, may set a record this year as tobacco bonds and AMR Corp. (AMR)’s Chapter 11 filing push the total to more than double the previous mark, said Richard Lehmann, publisher of the Distressed Debt Securities Newsletter.

Adding tobacco debt sold by states such as California and Ohio as well as AMR-backed munis, the total will eclipse the $8.62 billion high set in 2009, Lehmann said today. His newsletter in Miami Lakes, Florida, tracks defaults and uses a broader measure than those applied by other municipal analysts.

“We’re going to hit $20 billion this year,” Lehmann said today in a telephone interview. His tally wraps in everything from bankruptcies to missed payments and using reserve funds to service the debt. “These amounts will make 2011 the highest default year by far,” he said.

Not all analysts put AMR and tobacco debt in their totals for defaults in the $2.9 trillion market, because payments to investors haven’t been officially missed, said Matt Fabian, managing director of Municipal Market Advisors in Concord, Massachusetts. Fabian, who compiles payment defaults, said those have reached $2.1 billion this year, down from about $2.8 billion in 2010.

Lehmann’s Inclusions

Lehmann added AMR, the parent of American Airlines, to his total after it sought bankruptcy protection last week. He is adding Golden State tobacco bonds after California used reserve funds to cover debt service this month. AMR backed $3.2 billion of munis for airport facilities, bringing his total to $6 billion when added to $2.82 billion already included.

California and Ohio have acknowledged having to use reserve funds to make Dec. 1 payments on debt backed by revenue from legal settlements with tobacco companies. California has at least $7 billion of such debt and Ohio has $5.5 billion, Lehmann said. He predicted other tobacco bonds may be added.

With cigarette sales on the decline and AMR in bankruptcy in New York, both sets of bonds could miss payments in the future, Fabian said.

“The decline in smoking is happening at a much faster pace than anyone expected,” Fabian said by telephone.

John Hallacy, head of municipal research at Bank of America Merrill Lynch in New York, said he also wouldn’t count tobacco debt as in default until payments are missed.

“Drawing on reserves isn’t an event of monetary default,” Hallacy said by telephone. “But it is a prelude to one.”

Moody’s Investors Service in September cut the ratings on $3.5 billion of tobacco bonds to junk because a projected annual 4 percent drop in cigarette sales will lower payments to states.

To contact the reporter on this story: Darrell Preston in Dallas at dpreston@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net

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