Green Grass And High Tides
- Tuesday, 06/17/2014
As we continue to ride the 2014 performance wave in the municipal bond market, a colleague suggested that I address one important cause of 2013's poor performance: defaults.
I believe the price decline and outflows from municipal bond mutual funds, separate accounts, and ETFs were caused in part by the City of Detroit's Chapter 9 filing, downgrades of Puerto Rico, and downgrades of various other key issuers. However, according to the May 2014 update to the Moody's annual study, "U.S. Municipal Bond Default and Recoveries 1970-2013," I believe the municipal marketplace has been remarkably resilient.
Consider the following, according to Moody's:1
- The number of municipal bond issuer defaults has increased since the financial crisis in 2008, but default rates among such issuers generally remain low relative to corporate issuers.
- Municipal issuer recovery rates are trending lower than they've been in the recent past and are more variable in range than corporate issuer recoveries; yet municipal recoveries are still higher than corporate recoveries.
- Financially, governments are generally stabilizing, but Moody's expects some to remain pressured in the absence of a strong economic rebound.
- Moody's expects municipal bond issuer defaults to generally remain few in number.
Furthermore, according to the study, "Municipal issuer downgrades have outpaced upgrades over any 12-month period for every monthly cohort since 2009." This suggests to me the struggle our general economy has endured since the financial crisis of 2008. However, on the bright side, Moody's notes, "Such deterioration in credit quality seems to have stabilized since mid-2012." The analysis is done in the context of only issues they rate, and therefore, the assertion that there have been only 30 defaults (among rated issuers) since 2008 understates the true amount, which would include those issuers without ratings.
To look deeper, I turn to Municipal Market Advisors' (MMA's) default study, which, although only four years old, reveals a declining pattern of downgrades and defaults, and also covers issuers who are not rated by any of the services. MMA states in the February 2014 edition of "Municipal Insights," "It appears fewer issuers with ongoing impairments are falling into default now; many of the most vulnerable bond-financed projects have already defaulted; current economic challenges are somewhat less severe than in prior years; and/or capital market solutions are now more available."
MMA's study indicates that the number of defaulting issuers it has identified has declined from 107 in 2012, to 64 in 2013, and to 19 through the end of May 2014. This is evidence, I believe, of a potentially confidence-building trend for the asset class.
All of the above is but one element of consideration for municipal asset allocators, but, in my opinion, the municipal bond fund flows seem supportive of the recent emergence of interest from investors.
1Study universe covers only issuers and issues rated by Moody's Investors Service.