The “Oft-Told” Story of Municipal Bond Defaults
Last week’s article on municipal bond defaults from Liberty Street Economics, published on the New York Fed’s web site, received a fair amount of media attention. You can check it out here: http://libertystreeteconomics.newyorkfed.org/2012/08/the-untold-story-of-municipal-bond-defaults.html
Unfortunately, the article’s “findings” should be old news for even the most casual observer of the muni market, namely: (1) unrated bonds have historically defaulted at a much higher rate than rated bonds; (2) there is a “self-selection” phenomenon involved in going through the process of obtaining a rating and (3) “non-essential” service revenue bonds default at a higher rate than essential service bonds.
All these observations have already been well-documented and discussed at length in Chapter 4 of my book, “Investing In The High Yield Municipal Market”.
To give credit where credit is due, the Liberty Street article did make one interesting point: the default record on municipals seems to be less correlated to the economic cycle than is the case for corporate bonds. It is true that, while overall economic factors do impact State and local governments’ revenue stream, it’s really the “micro” factors that lead to municipal defaults (“willingness to pay” being one, among others). As the authors stated, “municipal bond defaults may be more of a function of idiosyncratic factors associated with individual sectors or issues than the result of broad macroeconomic developments”.
This is why accurate credit selection is such a challenging task in today’s de-commoditized muni market.
