Kroll report contends U.S. municipal bonds safe from default risk

By Susanna Moon

Chicago, Nov. 14 - Kroll Bond Rating Agency said that there will not be a material increase in municipal defaults over the medium term based on study of municipal bond defaults from the Great Depression to 2010.

"Market volatility over the past three years has led some to question the fundamental credit worthiness of the U.S. municipal bond market and to predict a wave of upcoming defaults," KBRA president Jim Nadler said in a statement.

"Our study finds that widespread municipal bond defaults have not been a feature of the most recent downturn, and we do not expect a sharp increase in defaults over the foreseeable future."

The study draws on data from more than 8,500 municipal bond defaults occurring during the period between 1929 and 2010, the release noted.

The study examines the causes of the massive wave of pre-war defaults and applies historical lessons to today's environment.

The agency said it will incorporate into its methodologies the lessons learned from the study and will address the ongoing challenges facing the municipal market.

The methodologies will include and focus on the ability of a municipality to effectively navigate increasing expenditures on social services, fluctuating revenues, an expected decrease in federal stimulus spending, long-term pension obligations and the need for increased infrastructure spending.

Structural markers

The analysis identifies several important structural differences between the municipal bond market of the 1920s and the current municipal bond market.

During the Great Depression, rapid growth in the volume of municipal bonds was spurred by the inception of the personal income tax, demand for paved roads accompanying the popularization of automobile travel and the relaxation of World War I controls on issuance.

"The legacy rating agencies have misread history and have yet to adjust their methodologies to account for recent structural changes in the municipal bond market," Jerome Fons, KBRA executive vice president and co-author of the report, said in the release.

Other key findings note that prior to World War II, the municipal bond market consisted mainly of issuances by states and cities.

By a wide margin, the largest contributors to municipal defaults during the Great Depression were U.S. cities. In terms of number of defaults, school districts came in second place, with counties, agricultural projects and municipal special assessment districts also contributing large dollar volumes.

Bank failures and bank holidays contributed to many Depression-era municipal bond defaults. The peak in the default wave coincided with the peak in bank closings. A large number of small taxing districts that contributed to Depression-era defaults have since been eliminated or consolidated, the release noted.

Revenue sources are more diversified today and federal safety nets protect a large portion of the deposits of municipal issuers, the agency contends.

Municipal bond issues that have been most problematic in recent times have been concentrated in the industrial revenue, health care and housing sectors, the release noted.

The prevalence of easily available bond insurance and bank facilities helped to ameliorate many of the more recent problems encountered by lower rated issuers, as well as allowing greater market access for small issuers, the release said.

Municipalities' ability to navigate pension, OPEB and other social entitlements will be a major factor in determining the strength of the future municipal bond market, the statement said.

State-by-state analysis found that between 1929 and 1939, 4,816 issuers defaulted on their obligations, affecting nearly $6.5 billion in outstanding debt. Depression-era defaults were also concentrated in a small number of states.

Generally, these states exercised little control over local issuers. During and after the Great Depression, Michigan, New Jersey and North Carolina implemented much stricter controls over their local issuers.

While the vast majority of the defaults occurred in special districts and small towns, the Great Depression did witness several large defaults by major cities.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.