August 15, 2012 / 6:00 PM / 5 years ago

US municipal bond defaults greater than rating data suggests-Fed

Aug 15 (Reuters) - U.S. municipal bond defaults are more numerous than the rating agencies report, according to data released on Wednesday by the Federal Reserve Bank of New York.

Combining data on unrated and rated bonds, researchers at the bank found that from 1970 to 2011 there were 2,521 defaults in the $3.7 trillion U.S. municipal bond market, compared to just 71 listed by Moody’s Investors Service.

They also found that from 1986 to 2011 alone there were 2,366 defaults, compared to the 47 defaults Standard & Poor’s reported over the same period.

“Although the low default history of municipal bonds has played a key role in luring investors to the market, frequently cited default rates published by the rating agencies do not tell the whole story about municipal bond defaults,” according to the report.

Usually, bonds sold by smaller municipalities or authorities and carrying higher risk of default do not have ratings from Moody‘s, S&P or Fitch Ratings.

“The unrated portion of the market can be home to municipal bonds of lower credit quality, exhibiting a higher frequency of defaults,” the study found.

“We believe that rated municipal bonds tend to be self-selected: issuers are less likely to seek ratings if their municipal bonds are not likely to achieve investment grade ratings,” it added.

According to the study, revenue bonds, which are issued for services and backed by pledged revenues, default more than general obligation bond, especially those where the services are not essential. Revenues bonds have made up “almost two-thirds of municipal new issuance since the mid-1990s,” it found.

Concerns about defaults are growing after three California cities filed for bankruptcy in the last two months and the bond insurance industry, which pays investors in the event of a default, shrinks.

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