Aug 20 The Federal Reserve Bank of New York has
riled analysts and other participants in the U.S. municipal bond
market with a report issued last week finding that defaults are
more prevalent than credit rating agencies suggest.
The report, which included non-rated debt, found that muni
defaults "happen much more frequently than most casual observers
are aware". For story on report, see
The conclusion is "patently absurd" and may cause people to
"question the reliability" of municipal information from the
Fed, said Daniel Berger, a senior market strategist at Municipal
Market Data, a unit of Thomson Reuters.
In interviews with Reuters, blog posts and web comments on
the Fed report, bond buyers, wealth managers, analysts and
others pointed to its su pposed s hortcomings.
No one was available at the bank to comment on reactions to
Some market experts were upset that the Fed looked only at
the overall number of muni defaults, and not their par value,
which would likely be a small portion of the $3.7 trillion muni
They also say that the report's emphasis on unrated debt --
which is inherently riskier -- is skewed and could lead an
unsophisticated observer to believe that the market, which is
generally considered one of the safest, is instead dangerous.
"The conclusion of the study is that there are more defaults
among non-rated transactions than rated ones. This is a big
revelation?" said Chris Mauro, director of municipal bond
research at RBC Capital Markets. "Why do you think they were
non-rated in the first place?"
In December 2010, Meredith Whitney rocked the muni market by
predicting that defaults would surge. That spooked individual
investors, who fled the market in the first quarter of 2011.
While investors have since returned to the market, some
participants still feel stung.
"Here comes the misleading statistic yet again," Gregory
Serbe, president of Lebenthal Municipal Asset Management in New
York, told Reuters in response to the Fed's report.
"We've had to, over the last few years, react to very
outsized reports of potential defaults that were coming down the
road," Serbe said. "That's unfortunate, because the bulk of
municipal bonds are going to pay their interest and principal in
a prompt and timely fashion."
MARKET TRIES TO UNDERSTAND SCOPE OF TROUBLE
Even so, some issuers are in serious trouble -- including a
trio of California municipalities that filed for Chapter 9
bankruptcy since June. On Friday, Moody's Investors Service said
it is considering credit rating downgrades in the state as
bankruptcies there will likely increase.
The bad news has put the marketplace on edge as it struggles
to understand the true scope of the problem and predict which
issuers could possibly go under. Nobody knows the answer for
In the Fed's report, researchers found that from 1970 to
2011 there were 2,521 defaults on bonds -- both rated and
unrated -- from about 55,000 issuers.
That number is far larger than the 71 defaults listed by
Moody's Investors Service over the same period of time, and just
47 listed by Standard & Poor's Ratings Services since 1986.
For corporate bonds, a market with an outstanding volume
double that of muni bonds by dollar value, but with just 5,700
issuers, Moody's reported 1,784 defaults and S&P reported 2,015,
the Fed study shows.
The Fed's report "painted an incomplete picture and perhaps
unwittingly gave the a platform for biased reporting,"
said Stephen Winterstein, head municipal strategist at
He and others point out that while 2,521 defaults may seem
like a significant increase over the dozens reported by the
rating agencies, those defaults likely represent a small share
of the market when measured by the par value of the bonds at
stake -- in part because they're generally much smaller bond
For example, Moody's rates an estimated 22,000 issuers, but
$3.36 trillion, or about 91 percent, of the market based on par
value. S&P likewise rates about 22,923 issuers, but $3.17
trillion, or 86 percent, of the market by dollar value,
according to Winterstein.
If the dollar value information were included, "the default
reports published by the rating agencies give us a different and
perhaps more comprehensive view of credit stress in the
municipal market," Winterstein said.
Some did find the report useful. One credit analyst said in
the report's comment section that it is "important to realize
the different default rates for the different sectors of the
The bank also spelled out the difference between safer,
general obligation bonds and often riskier revenue bonds. And it
noted that issuers who believe their bonds won't earn
investment-grade credit ratings are less likely to seek out
ratings in the first place.
Of the various kinds of markets, the world of municipal
bonds can seem fragmented, and its participants often assert
that it defies broad descriptions. Its 55,000 issuers cover 22
sectors, 50 states and 5 territories, with stratified credit
structures, experts said.
"Any sweeping generalization should be looked on with a
suspicious eye," Winterstein said.