April 30 (Bloomberg) -- Municipal bonds are defaulting at the slowest pace in at least five years as a growing economy lifts the most speculative corners of the $3.7 trillion market.
Local issuers have logged about $270 million of debt defaults this year as nine borrowers missed payments for the first time, down from 25 at the same point of 2013, according to data from Concord, Massachusetts-based Municipal Market Advisors. It’s the fewest failures in the research firm’s database, which goes back to 2009.
A rebound in property taxes and real-estate values after the recession that ended almost five years ago is filtering down to the riskiest parts of the municipal market, where governments sell bonds backed by revenue from projects such as museums and housing development. Junk-grade local bonds are outpacing the broader market in 2014, after trailing last year.
“When there are fewer defaults, that’s good for the market because investors become more optimistic,” said Matt Fabian, an analyst at Municipal Market Advisors. “They can afford to take more risk.”
With defaults ebbing and benchmark yields plumbing 10-month lows, investors are shifting money to high-yield munis. Funds that focus on the bonds, which carry ratings below investment grade, have added cash for the past 16 weeks, according to Lipper US Fund Flows data.
High-yield munis have earned 6.7 percent this year through April 28, after the biggest quarterly gain since at least 2010, according to Bank of America Merrill Lynch indexes. In 2013, the securities lost 6.2 percent. The broader market has advanced 5.1 percent this year amid a dearth of bond sales.
The slide in defaults tracks a broader improvement in municipal finances. State tax collections have risen in every quarter since the start of 2010, according to the Nelson A. Rockefeller Institute of Government in Albany, New York. That’s fostering a recovery for communities still contending with pressures from the 18-month recession that ended in June 2009.
The fiscal strains pushed three California cities, Detroit, and Central Falls, Rhode Island, into bankruptcy since 2008. Faced with a struggling economy and mounting debt, junk-rated Puerto Rico borrowed $3.5 billion last month, giving it enough cash through mid-2015.
“It does come in parallel with positive trends in the market -- states are generating surpluses, and tax bases are stabilizing,” said Fabian.
None of this year’s defaults involved general-obligation bonds, which are backed by a government’s taxing power and pledge to repay, according to Municipal Market Advisors. Instead, local authorities issued the securities, which are guaranteed by revenue from the projects that received the funds.
Among those defaulting were the owner of North Adams Regional Hospital, a money-losing medical center in northwestern Massachusetts that filed for bankruptcy this month.
Others included bonds issued by government agencies that financed the Lewistown Commerce Center, a shopping complex outside Richmond, Virginia; and a privately operated detention center in Arizona for undocumented immigrants.
“It underscores why situations like Detroit and Puerto Rico and a few cities in California are, if not unique, farther out on the spectrum,” said Natalie Cohen, head of municipal research for Wells Fargo Securities LLC in New York.
Yesterday’s bankruptcy filing by Energy Future Holdings Corp., the Texas power company that was taken private in 2007 in the biggest-ever leveraged buyout, may add to the default tally because of related munis, said Fabian at MMA.
The decline in distress among borrowers may bolster the confidence of individual investors, who own the bulk of the local-debt market, said Charles Pulire, who helps oversee about $30 billion of munis at OppenheimerFunds Inc. in Rochester, New York.
“You’re going to have an investor base that, I think, starts to have their fears quelled,” said Pulire. “That all bodes well if people are more comfortable taking on that credit risk.”
Municipal defaults have been rare, and remained so even as they increased following the recession.
Moody’s Investors Service said last year that there was an average of 4.6 defaults annually from 2008 through 2012 on bonds it rated, up from 1.3 from 1970 through 2007. Typically, about 70 percent of such cases are related to health-care providers and housing developers that sell tax-exempt bonds through government agencies.
Pension deficits at the local level, as well as financial pressure on hospitals from President Barack Obama’s health-care overhaul, remain a source of strain, said Jon Schotz, a money manager who focuses on defaulted munis at Kayne Anderson Capital Advisors in Los Angeles, which oversees about $20 billion.
“There’s more risk in the muni sector than there was before,” he said.
More than half the borrowers that missed payments this year had documented financial difficulty, according to MMA.
North Adams Regional, whose parent, Northern Berkshire Healthcare Inc., defaulted on the hospital’s muni debt in March, had been struggling for years and last came out of bankruptcy in 2012.
The improving economy is propping up bond-funded projects and borrowers’ ability to raise money to keep developments operating as they try to turn a profit, Fabian said.
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