California Bankruptcies Belie Decrease in Defaults: Muni Credit

California Bankruptcies Belie Decrease in Defaults
The City Council of San Bernardino , a city of 209,000 about 65 miles east of Los Angeles, voted July 10 to pursue bankruptcy after officials learned they might not have enough cash to pay workers. Photographer: Jonathan Alcorn/Bloomberg

U.S. localities are defaulting at the slowest rate in three years, showing that three California municipalities’ decisions to file for bankruptcy protection within two weeks isn’t a sign of wider stress in the tax-exempt market.

One hundred municipal issuers defaulted nationwide for the first time in the year through July 10, the least in a 12-month period since Concord, Massachusetts-based Municipal Market Advisers began collecting the data in 2009. The decline is counter to the “hundreds of billions of dollars” of defaults that banking analyst Meredith Whitney projected in 2010.

The drop also signals that the finances of issuers in the $3.7 trillion market are improving three years after the end of the longest recession since the 1930s. It may bolster confidence in munis, which are on a pace to beat Treasuries and corporate bonds for a second straight year when adjusting for volatility.

“While the frequency feels like it’s picking up, the amount of debt remains very small,” said Guy Davidson, who oversees $31 billion as director of municipal investments at AllianceBernstein LP in New York.

The City Council of San Bernardino, a city of 209,000 about 65 miles (105 kilometers) east of Los Angeles, voted July 10 to pursue bankruptcy after officials learned they might not have enough cash to pay workers. The move followed Chapter 9 filings by Stockton and Mammoth Lakes in the past two weeks.

Bonds Rally

Even with the bankruptcy vote, municipal debt rallied yesterday. Yields on 10-year benchmark municipals fell to a one-month low of 1.82 percent, data compiled by Bloomberg show.

Municipal mutual funds have added $15.7 billion this year, the most for the period since 2009, Lipper US Fund Flows data show. Bondholders are putting to work a record wave of about $142 billion in the three months through July from bonds that are coming due or being refinanced, according to Citigroup Inc.

“The technicals favor municipals at the moment in that there’s still strong demand and limited supply,” Davidson said.

Whitney predicted in a December 2010 broadcast of CBS Corp.’s “60 Minutes” that municipal defaults would total “hundreds of billions of dollars” in the coming year.

Instead, 2012 is shaping up as a year of diminishing failures. Forty-two issuers have defaulted for the first time this year, compared with 68 for the same period of 2011, MMA data show. For all of last year, there were 126 cases.

Beating Budgets

Fewer municipal issuers are defaulting as revenue collections improve. Thirty-one states garnered more revenue than their budgeted estimates for the fiscal year that ended last month, according to the National Governors Association.

“We expected there to be a handful of problems, not a sweeping hundreds of billions of dollars,” said Matt Fabian, a managing director at MMA, in a telephone interview.

Whitney didn’t respond to an e-mail request for comment, and she was unavailable for a phone interview when contacted at her New York office.

States and localities typically default less often than companies. Only 0.13 percent of municipal bonds rated by Moody’s Investors Service fell into that category from 1970 to 2011, compared with more than 11 percent of company debt.

After adjusting for volatility, tax-exempt debt has earned 2.3 percent this year through July 10, according to data compiled by Bloomberg and Bank of America Merrill Lynch. That compares with 1.7 percent for corporate debt and 0.8 percent for Treasuries.

Declining Revenue

San Bernardino faces a $45 million deficit and declining tax revenue, according to a budget analysis on the city’s website.

Stockton, a community of 292,000 east of San Francisco, filed for Chapter 9 last month, becoming the largest U.S. city to go into bankruptcy. Mammoth Lakes, a ski destination, filed this month saying it can’t pay a $43 million legal judgment, more than twice its general-fund spending for the year.

Since 2008, AllianceBernstein has been favoring debt backed by dedicated revenue such as utility payments and tolls on the view those streams would offer more cushion during the 18-month recession that started at the end of 2007. The company allocates about 10 percent of its municipal portfolios to local-government debt, less than that segment’s 12 percent share of the municipal market, Davidson said.

Even with the California developments, investors will buy munis for their relative safety and value, Davidson said.

“It would take a much larger issuer or a lot more smaller issuers to shake investors’ confidence and I don’t think we’re there yet,” Davidson said.

Following are pending sales:

DORMITORY AUTHORITY OF THE STATE OF NEW YORK plans to sell $1 billion of debt backed by personal-income-tax revenue as soon as July 17 through competitive bid, according to bond documents. Proceeds will help finance capital projects for the State University of New York system and the City University of New York and support environmental infrastructure projects. Fitch Ratings rates the bonds AA, third-highest. (Added July 12)

MIAMI-DADE COUNTY, Florida, is set to issue $540 million of sales-tax revenue bonds as soon as next week, according to data compiled by Bloomberg. The sale will refund debt and help finance transportation projects, according to bond documents. (Added July 12)