MuniLand: Low Default Rates, but Shifting Sector Risk

Moody’s Investor Service reports that municipal bond defaults have increased since the financial crisis, but remain extremely infrequent. From early 2008 to 2013, there have been 30 defaults, which increased the average annual number of defaults to 5 per year versus 1.3 per year from 1970 to 2007. Moody’s calculates the annual muni market default rate at 0.03% for the last 5 years versus 0.01% during the 1970 to 2007 period. That is an extremely low rate of default. The interesting fact about municipal defaults is the shift in composition from healthcare and multi-family housing credits to general government default. For example, Puerto Rico defaulted on a bond issue over the weekend. At SNWAM, we often talk about how general government debt risk profile has increased. The additional risk, in our opinion, is caused by structurally imbalanced operating environments, and in particular pension costs outpacing overall revenue growth. As an active portfolio manager, we mitigate this risk by allocating more bonds to essential service credits and dedicated tax revenue bonds from general obligation debt. Looking forward, we don’t see the trend in general government risk abating. As new credit and economic risks develop, your portfolio composition will change to reflect the optimal risk reward balance.

Source: SNWAM Research, Moody’s Investor Service “US Municipal Defaults and Recoveries, 1970 – 2013” May 7, 2014