Fewest Defaults Since 2009 Masked by Detroit RecordBrian Chappatta and Priya Anand
Municipal issuers are defaulting at the slowest pace in at least four years even as Detroit’s record bankruptcy and losses on Puerto Rico debt fuel the market’s biggest declines since 2008.
The 45 first-time defaulters this year through Nov. 20 range from bonds used to build parking garages at Yankee Stadium in New York, to a technical school in Muskegon, Michigan, data from research firm Municipal Market Advisors show. It’s less than half the number from a year earlier as an expanding U.S. economy has helped state tax revenue grow for 15 straight quarters, according to Census Bureau data.
The dropping tally belies an increase in the dollar amount of failures after Detroit opted to forgo debt payments before its $18 billion Chapter 9 filing in July. The Motor City’s move has helped fuel $52 billion in outflows from muni mutual funds this year, driving local bonds to deeper losses than Treasuries and company debt, Bank of America Merrill Lynch data show.
“Municipal credit quality is improving from the lows of 2008 and 2009,” said Steven Permut, who oversees about $6 billion of local debt at American Century Investment Management in Mountain View, California. “Puerto Rico and Detroit create opportunities in the asset class because so many people view the entire market as having systemic risk. We view these as isolated events.”
More than four years after the longest recession since the 1930s, local finances are strengthening. U.S. cities in 2013 predict their first revenue increase in seven years, according to the Washington-based National League of Cities.
Localities aren’t the issuers at greatest risk. The most default-prone bonds in the $3.7 trillion market are from industrial-development agencies, housing authorities, nursing homes and health-care facilities, according to the Federal Reserve Bank of New York.
Banking analyst Meredith Whitney’s prediction in December 2010 of “hundreds of billions of dollars” of municipal failures in the following 12 months heightened the focus on localities’ finances.
While her prediction never materialized, Jefferson County, Alabama, sought bankruptcy protection 11 months later. At the time, it was the biggest Chapter 9 filing in U.S. history. A judge last week approved the county’s plan to exit bankruptcy. The plan included a $1.8 billion debt offer this month and reduced payments to creditors.
The statistics from Concord, Massachusetts-based MMA count Jefferson County as failing to pay for the first time in 2013. The case represents at least $3.5 billion of the $8.1 billion in defaults this year by par value, the most since at least 2009.
“The misperception about credit is still there, but we don’t see a lot of other situations developing beyond the ones we already know,” said Matt Fabian, a managing director at MMA. “The riskier sector credits are defaulting far less frequently, and the default database doesn’t have a lot of other cities entering.”
Detroit’s filing came after decades of decline left the city of about 700,000 too poor to pay billion of dollars owed to bondholders, retired police officers and city workers. Emergency Manager Kevyn Orr sought court protection from creditors after too few would accept his plan to repay $11.5 billion in unsecured debt with $2 billion in borrowed money.
The debt deemed unsecured included general obligations and certificates of participation. Detroit missed payments on the latter securities in June, and then failed to repay owners of some general obligations in October. Individuals pulled a record $4.5 billion from muni mutual funds in one week in June, Lipper US Fund Flows data show.
Withdrawals have persisted for 26 straight weeks, fed also by speculation that Puerto Rico’s shrinking economy will make it harder for the island to repay bondholders. The U.S. territory and its agencies had $70 billion of debt as of June 30, according to the island’s Government Development Bank, which handles capital-market transactions.
Puerto Rico officials said on a webcast last month that they had sufficient funds to avoid issuing bonds before June 30 if interest rates are too high.
The island’s general obligations have the lowest investment grades and negative outlooks from the three biggest rating companies. Money managers Pacific Investment Management Co. and BlackRock Inc. have said a cut to junk may roil the local-debt market since more than 75 percent of muni mutual funds hold the commonwealth’s securities. Its debt is tax-free nationwide.
Local-bond losses this year have exceeded those on federal securities and company bonds. The U.S. fixed-income market has declined in 2013 on bets the Fed will curb its $85 billion in monthly bond purchases, leading to higher interest rates.
The 2.7 percent decline in munis through Nov. 25 compares with a 2.4 percent drop in Treasuries and 1.4 percent loss for corporate debt, Bank of America data show.
Munis are still “a very strong asset class at attractive values,” American Century’s Permut said.
He pointed to bankruptcy filings last year by California’s Stockton and San Bernardino that failed to trigger a wave of such moves. The decisions pushed the extra yield on California issuers to a six-month high. Since then, the spread on the state’s general obligations reached the lowest since 2008, Bloomberg data show.
“From a pure default perspective, things are getting a lot better,” Fabian said. “We are going to see less focus on defaults and less concern about defaults in 2014.”
Issuers nationwide are offering about $570 million in long-term debt this week, the least since January, with benchmark yields close to a two-month high. The market is closed tomorrow for the U.S. Thanksgiving holiday.
The interest rate on AAA 10-year munis is 2.89 percent, compared with about 2.7 percent on similar-maturity Treasuries.
The ratio of the yields, a measure of relative value, is about 107 percent, the highest in a month. It compares with an average of 94 percent since 2001. The larger the number, the cheaper munis are compared with federal securities.