July 5, 2011 / 9:57 PM / 7 years ago

Muni defaults defy forecast in 1st-half 2011

NEW YORK (Reuters) - Six months after dire predictions rocked the $2.9 trillion U.S. municipal bond market, the actual value of bond defaults in the first half of 2011 was well under $1 billion, according to data provided to Reuters by Income Securities Advisors.

Only 26 issues defaulted in the first half of the year, down from 60 in the first six months of 2010, the data showed. The value of defaults fell sharply to $818.2 million in the first six months of 2011 compared to this point last year when defaults totaled about $2.8 billion.

Late in 2010, Wall Street analyst Meredith Whitney -- who in 2007 predicted that Citigroup (C.N) would need a massive capital infusion -- spooked investors when she forecast 50 to 100 “sizable defaults” by local governments amounting to hundreds of billions of dollars.

The remarks came at a time when the market was already roiled by a collapse in state and local revenues due to the recession and financial crisis. Many states, cities and counties had to raise taxes, slash spending and turn to the federal government for help.

But even as states and local governments continue to show stress in the wake of the recession, there were only 12 second-quarter muni defaults totaling $403 million, down from more than $1.7 billion at the same point last year, the ISA data showed.

“The numbers are actually normal for a non-crisis type environment,” said Richard Lehmann, the president of ISA, an investment advisory and research firm based in Florida.

The largest default in the second quarter was Florida’s Tolomato Community Development District, Lehmann said.

“Default is only going to happen when the municipality runs out of cash,” Lehmann said. “If you don’t pay your bonds, then you lose the conduit for maintaining your liquidity. So it’s one of the last things you’re going to cut.”

    Lehmann’s review of rated and unrated municipal debt defines a default as the failure of the bond obligor to make a scheduled interest or principal payment to the trustee, regardless of who holds the bonds or whether bondholders lost money.

    Conversely, corporate debt registered 5 defaults amounting to $1.8 billion in the second quarter of 2011, Lehmann said. for a total of 11 corporate bond defaults in the first half of this year, totaling almost $3 billion.

    Still, trepidation about risks facing public sector debt has led investors to turn away from municipal bonds.

    U.S. municipal bonds funds recorded 29 straight weeks of outflows until the week ended June 8. That week’s $274 million of inflows sparked hopes that retail investors were returning to the market they traditionally dominate.

    The third quarter of 2011, however, began with a default. On July 1, a Florida public authority missed a $5 million bond payment and went into default on $116 million worth of bonds sold to build a toll bridge.

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