Municipal defaults are creeping up, suggesting more bondholder pain to come

Municipal bond defaults have been on a steady climb since 2018, and look set to continue that trend in 2021, a worrisome sign given that credit conditions are likely to only worsen from here, according to an analysis published October 6.

There have been 47 defaults so far this calendar year, according to that analysis, a weekly summary of default trends from muni-market stalwarts Municipal Market Analytics, and recent history suggests the fourth quarter will see at least 13 more, putting the annual  at 60. That would be the highest yearly total, other than 2020, since 2016.

It’s important to note that none of the defaults discussed here impact bonds issued by state and local governments and secured by tax revenues. Bonds issued by Puerto Rico, which is in the midst of a major restructuring process, are also excluded.

Senior living facilities are by far the biggest offender, with 27 defaults so far in 2021, followed by charter schools. Nearly all the defaults of the past few years fall into what MMA terms a “risky” sector, also including jails, student housing, and parking.

One of the biggest drivers of the surge of defaults in 2020 was the “industrial development bond” category, a sector also sometimes called “industrial revenue bonds.” That category was elevated in 2018 and 2019 as well, reflecting two high-profile issuers, FirstEnergy and PG&E, MMA notes.

State and local governments have issued more pension bonds this year than ever before

U.S. municipalities are increasingly issuing bonds to pay down their accumulated pension obligations, a step akin to “gambling,” according to an analysis out Monday.

The report, from muni bond market stalwart Municipal Market Analytics, notes that nearly 80 state and local governments have issued such bonds so far in 2021, the most on record back to 2000. The amount issued so far, $10.5 billion, is dwarfed by the roughly $16 billion issued in 2003.

Sweetwater and Former Financial Officer Take Deal in SEC Fraud Case

Manipulating financial information that is reported during bond sales is a violation of the Securities Act, as VOSD reported back in November 2018, before the SEC’s investigation started.

Regulators would want to know, “Is it a mistake or was it intentional?” Matt Fabian, a bond markets researcher at Municipal Market Analytics, told VOSD at the time. “Even if it is a relatively small misrepresentation of information, regulators take that very seriously.”

SEC investigators ultimately found Michel misled investors as well as a credit rating agency.

Record Number of Muni Issuers Bet on Pension Debt With Rates Low

Many issuers are drawn by the arbitrage opportunity and the bonds “probably look pretty attractive” said Lisa Washburn, a managing director at research firm Municipal Market Analytics. The risks they carry, however, mean they’re “not a sure thing.”

Main Street Pensions Take Wall Street Gamble by Investing Borrowed Money

State and local governments have borrowed about $10 billion for pension funding this year through the end of August, more than in any of the previous 15 full calendar years, according to an analysis of Bloomberg data by Municipal Market Analytics. The number of individual municipalities borrowing for pensions soared to 72 from a 15-year average of 25.

Cities and states on the frontline of climate change aren’t always upfront about risks. Does the municipal bond market care?

“It’s just amazing, the power of the (muni-bond) tax exemption and the avoidance of taxes. It’s an unbelievable force in America,” said Thomas Doe, president of Municipal Market Analytics, a Massachusetts-based provider of muni-bond market data. 

“Look at the migration to Florida, Texas, and Arizona,” Doe said. “You may be able to live there for a short period of time, but it’s not going to be a 20-year experience.” He calls it denial: “It won’t happen while I’m living there.” “I can’t believe there will be a day when water won’t come out of the tap.”

Billion-Dollar Muni Deals a Rarity as Free Cash, Revenue Pile Up

But a more fundamental reason may be at work, which is that most of the nation’s 90,126 units of government -- the tally in the Census of Governments 2017 data -- don’t seem to like debt.

That may explain why they pay some of it off every year and why 31% of it will mature or be called by the end of 2026, according to a study by Municipal Market Analytics.

Municipal Bonds Are the Apple of Fixed Income Investors’ Eyes

The yield in question—known as yield to worst—is the lowest rate the investor can expect to earn short of a default."

"Still, investors can’t get enough of the bonds," the article said, noting the high interest in munis. "Prices have surged even though outstanding muni debt has swelled by more than $100 billion in the year ended March 31, according to Federal Reserve data. Cities and states could probably sell an additional $89 billion in bonds without meaningfully driving down prices, according to an analysis of lending capacity by Municipal Market Analytics."

An Epidemic of Bad Budgeting

Bad fiscal practices like these are increasingly common among local governments, which claim that Covid-19 required extraordinary measures. A recent study by Matt Fabian and Lisa Washburn of Municipal Market Analytics, examining 442 municipal bond offerings in the second half of 2020, found that at least a quarter used the money for “direct deficit financing” (floating new debt to close budget gaps) or “indirect deficit refinancing” (issuing debt to pay for projects that governments previously had financed with tax revenues). That so many local governments resorted to such financing so quickly—just months after the lockdowns began—suggests how little financial flexibility and reserves many of them had.

Wall Street says NJ is in better fiscal shape, giving Murphy something to brag about

“I think the long-term concern is New Jersey managing its long-term liabilities,” Lisa Washburn, a former managing director at Moody’s Investors Service who now works for the independent research firm Municipal Market Analytics, said in an interview with NJ Spotlight News.

Its bond rating can be a key factor in determining how cheap and easy it is for a state to borrow money to fund long-term investments in schools and in infrastructure like roads and bridges that cannot be paid for in a single budget.

A strong bond rating can also lead to lower borrowing costs that ultimately get funded out of the state budget — good news for taxpayers. New Jersey’s current budget totals $46.4 billion after lawmakers approved a major spending hike in late June.

Pimco Veterans Look To Shake Up 'Old School' Muni Loan Market

In July, the Poulsbo, Washington-based company, which was founded in 2019, made further inroads when California’s Coachella Valley Unified School District borrowed through its platform. It was one of five loan transactions Alpha Ledger has completed this year, after two in 2020.

Banks held about $197 billion of direct loans to municipalities as of the second quarter, according to research firm Municipal Market Analytics. Alpha Ledger wants to move into the public-debt arena -- which accounts for the brunt of municipal borrowing -- some time in 2022.

American Dream Mall Draws on Reserves to Make Bond Payment

Lisa Washburn, managing director at Municipal Market Analytics, said it “seemed inevitable” that American Dream would need to tap reserves on debt tied to mall sales.

“The economic shut-down and travel disruptions related to the pandemic could not have come at a worse time for the project, which had only partially opened and was already contending with a shifting retail landscape,” Washburn said in an email. “Now it needs to overcome concerns about congregating indoors with strangers.”

Puerto Rico Oversight Board reaches deal with Ambac, FGIC

“In big restructurings like these, it’s usually the first to settle that get the best terms,” said Municipal Market Analytics Partner Matt Fabian. “So this is probably the best they could hope for. If nothing else, it’s a step towards mitigating their Puerto Rico exposure, which should be their ultimate goal.”

Cities Awash in Rescue Cash Seek to Use It to Pay Down Debts

It’s unclear how much of an economic impact it would have if the Treasury rolled back some of the limits. But many governments sold debt in the early days of the pandemic as they prepared for tax revenues to tumble. In the second half of 2020, for example, at least one quarter of state and local government debt sales over $100 million included a material element of deficit financing, according to Municipal Market Analytics.

Special Briefing on the Biden Infrastructure Plan: Resilience, Equity, and Federal Investment

"I look at all infrastructure through the climate lens," Municipal Market Analytics (MMA) President Thomas G. Doe said as part of Special Briefing on the Biden Infrastructure Plan: Resilience, Equity, and Federal Investment. "It's looking not just at existing projects and their risk, but also what the future probable risks are for any new efforts that are being done, and, especially, not just on durability but also on equity as well."

‘Trying to strangle local governments’: What happens when states and their cities become adversaries?

“Pre-emption happens all the time,” said Matt Fabian, a partner with Municipal Market Analytics. “It becomes an issue when nonrational reasons drive decisions or where the state sees the city or its residents as an adversary. There can be a certain tribalism that hinges on race or how people vote.”

Fabian, whose firm offers research for municipal bondholders, calls politically motivated pre-emption “an underappreciated risk in the muni-bond market. In general when cities default it’s less about finances and more about what the state does to not help the city navigate a situation. The political factor, the relationship and potential antagonism between a city and its state, is widely underinvestigated.”

Municipal-bond defaults are vanishingly rare, but conflict between city and state is a common thread in many recent episodes of municipal distress, which have often occurred in places where the city’s residents are primarily Black.

https://www.marketwatch.com/story/what-happens-when-states-and-their-cities-are-adversaries-11625756500

Washington wants to bring back Build America Bonds. The muni market isn’t buying it

“State and local issuers are deeply ambivalent about the BABs program,” said Matt Fabian, a partner with Municipal Market Analytics. “It’s being talked about like it’s the core of the infrastructure program, but issuers in general don’t care because demand for tax-exempt bonds is now the strongest it’s ever been,” he said.

“We are flooded with demand,” Fabian said.

The yield on the S&P Municipal Bond General Obligation Index is currently about 1.93%, among the lowest on record back to 2009. Bond yields and prices move in opposite directions.

While Washington lawmakers may believe that a lower interest rate would help issuers, thereby boosting the amount of overall spending on infrastructure, MMA’s calculations show the federal subsidy would have to be at least as high as 50% to make BAB issuance worth it.

More to the point, Fabian told MarketWatch, “state and local infrastructure spending is a zero-sum game. Governments only have so much in revenues to pay back bonds, no matter how low the interest rate.”

https://www.marketwatch.com/story/washington-lawmakers-want-to-bring-back-build-america-bonds-the-muni-market-isnt-buying-it-11621533281

Distressed Muni Borrowers Are Still Piling Up in Pandemic’s Wake

Eight muni borrowers became distressed last week, lifting this year’s tally to 76, according to Municipal Market Analytics. That puts 2021 on track to exceed almost every year since 2012 in terms of impairments. Only 2020, when the coronavirus caused some of the worst market turmoil on record, was worse.

https://www.bloomberg.com/news/articles/2021-06-03/distressed-muni-borrowers-are-still-piling-up-in-pandemic-s-wake

Yield-Starved Investors Snap Up Muni Bonds

A $34 million Illinois bond rated triple-B minus—at the bottom of investment-grade—and due in 10 years recently traded for around 128 cents on the dollar, according to data from Electronic Municipal Market Access. It yielded 1.86%, down from 2.22% when issued in March.

“There are just far more lenders than there are borrowers,” said Matt Fabian, head of research at Municipal Market Analytics. “That keeps municipal-bond yields pinned as low as you can go.”

The average yield on 10-year triple-A-rated munis was 0.82% at Friday’s close, according to Bloomberg Barclays data. That is less than 0.2 percentage point above the record low yield of 0.68% from February, in data going back to 1993. Yields fall when bond prices rise.

https://www.wsj.com/articles/demand-for-municipal-bonds-lowers-borrowers-costs-11620572580

Statehood for Puerto Rico would kill its triple-tax-exemption

Only those who reside in Puerto Rico would still enjoy an exemption from state and municipal-level income taxes on the bonds’ interest if it becomes a state. There is no accurate public figure but in recent years some have estimated that Puerto Rico residents own 20% of the commonwealth's bonds.

Aside from the loss of the triple-tax-exemption, “it’s hard to see Puerto Rico being worse off, or less able to raise capital, if it were a state vs. current status,” said Municipal Market Analytics Partner Matt Fabian.

“We have a hard time seeing Puerto Rico statehood as a negative scenario for bondholders, arguing that a material portion of Puerto Rico’s past financial and economic troubles reflected Puerto Rico’s pervasive reliance on a disinterested and uninvolved U.S. Congress," analysts wrote in the April 19 MMA Outlook. "Further, any transition from territory to state would require substantial revenue and administrative reforms and would reasonably involve years of related preparation.”

https://www.bondbuyer.com/news/statehood-for-puerto-rico-would-kill-its-bond-triple-tax-exemption