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Muni Defaults Up 111% and Down 38%, Depending on Data

Municipal bond defaults in early 2012 were up dramatically — or down dramatically — depending on how you look at the data.

Distressed Debt Securities Newsletter has collected data through March 1 showing there were 23 defaults totaling  $1.03 billion, an increase of 111.4% measured by par value. In the same period during 2011 there were 23 defaults totaling $492 million.

By contrast, Standard & Poor’s Capital IQ found that for Jan. 1 to March 1 muni defaults were down by 37.6% measured by par value.

In the same period in 2011 there were 10 defaults totaling $107 million. In the same period this year there were just four defaults totaling $67 million, according to S&P Capital IQ.

The discrepancy carries over to their annual default numbers.

Where the newsletter found that defaults went up 401.6% in 2011 compared to 2010 to $25.36 billion, the Standard & Poor’s group found that they were down 60.8% for the same period to $1.06 billion.

The explanation for the difference turns out to be relatively straightforward: The organizations use different definitions for what constitutes a default.

The newsletter says there is a default anytime a municipal issuer invades its debt-service reserve fund or there is a declared bankruptcy, said newsletter editor Jack Colombo.

A debt-service reserve requirement is “a legally binding covenant of a obligor to maintain a specific available liquid reserve to meet debt service requirements in the event pledged revenues are insufficient,” according to the Handbook of Municipal Bonds.

Defaults are “issuer-specific” events and not “bondholder-specific” events, said the newsletter’s publisher, Richard Lehmann. In other words, a default should be defined by what muni issuers do and not by whether it affects bondholders.

The Standard & Poor’s group compiles statistics on what it calls technical defaults — a violation of covenants or use of reserves — as well as monetary defaults — when a borrower misses a payment to bondholders.

However, S&P primarily publicizes the monetary defaults. Only if a bondholder does not get paid or doesn’t get paid on time does Standard & Poor’s declare a monetary default. If an issuer fails to make an interest payment, the S&P group considers the entire bond issue’s par value to be in default.

S&P attempts to track the entire municipal bond market.

About 0.5% of all municipal bonds are currently in monetary default, measured by par value, according to Standard & Poor’s fixed-income group.

The group gets this information, unlike the default information, from the S&P Municipal Bond Index.

The index tracks over $1.3 trillion in muni bonds, which is about 35% of the par value of the total $3.7 trillion municipal bond market.

The index includes both rated and unrated bonds.

Asked about the divergence in trends between the S&P and newsletter default measures, two analysts pointed to so-called tobacco bonds, some of which drew down reserves last year to make debt service payments. Richard Ciccarone, chief municipal strategist at McDonnell Investment Management LLC, and Allen Schankel, managing director of fixed-income research at Janney Montgomery Scott, said that had a dramatic effect on the newsletter’s measurement of defaults.

Ciccarone also said the bankruptcy filing by American Airline parent AMR Corp. in November also led the newsletter to count large amounts of airport conduit bonds as defaults.

S&P Capital IQ has counted only $155 million in American Airlines-related debt as in monetary default. However, American has issued a total of $3.2 billion in special facilities revenue bonds. The newsletter is counting the bonds beyond the $155 million group as being in default, Lehmann said.

The defaults defined by debt-service reserve draws may foreshadow future monetary defaults, according to Ciccarone.

Natalie Cohen, managing director of Wells Fargo Securities, agrees that could be the case. “Technical defaults are going to be ahead of monetary defaults, but not all will ripen into monetary defaults,” she said.

Schankel noted that only a few million dollars was drawn from reserves to make payments on the tobacco bonds — bonds backed by revenues provided by the Master Settlement Agreement between various municipalities and the major tobacco companies.

These draws will probably be cured in the next few months, Schankel said. However, the February issue of Distressed Debt Securities Newsletter predicts that the invasion of debt reserves for tobacco bonds will prove to be just the first step to more serious defaults.

The three main rating agencies also put out year-in-review reports about defaults. Standard & Poor’s Ratings Services annually generates year-in-review reports that are separate from the reports that Standard & Poor’s Indices issues over the course of a year based on figures from S&P Capital IQ and the S&P Municipal Bond Index.

The rating agencies’ reports disclose and examine defaults in the previous year by issuers and bond issues that the agencies currently rate.

S&P reported that six bond issues it rates defaulted in 2011. Moody’s had four defaults, and Fitch had one.

The ratings agency reports do not specify par value.

S&P Ratings Services recorded zero defaults in 2007, five in 2008, zero in 2009, three in 2010 and five in 2011. In the same period, Moody’s Investors Services noted four in 2007, five in 2008, two in 2009, seven in 2010 and four in 2011. Fitch Ratings saw two defaults in 2007 and one default in each of the following four years.

Fitch downgraded the one Fitch issuer that defaulted in 2011 to BB from BB-plus on Oct. 1, 2009. On March 30, 2010, the agency downgraded it to B from BB. On Feb. 1, 2011, Fitch downgraded it to CC from B.

On June 17, 2011 Fitch dropped it to D after it declared bankruptcy. And on Dec. 8, 2011 the rating was withdrawn.

Fitch defines a default as either a failure to make a promised payment, a bankruptcy or a “distressed debt exchange of an obligation, where creditors were offered securities with diminished structural or economic terms compared with existing obligations.”

Moody’s uses similar conditions to declare a muni bond in default. S&P says defaults occur when bondholders do not receive money that has been promised to them.

Muni investors have paid increased attention to muni defaults in recent years as the economic downturn put intense stress of state and local government finances.

Until recently such defaults were rare and generally only affected smaller issuers. In the last few years high-profile government issuers like Jefferson County, Ala., (population 658,000), and Pennsylvania capital Harrisburg have defaulted. In late February, Stockton, Calif., (population 292,000) voted to default on some of its bonds.

Most of Stockton’s bonds are insured. Because the one bond not insured on March 1 drew on reserves, the default was not counted in S&P Capital IQ data.

“One thing these figures show is that the days when we have a zero-loss market are gone,” Ciccarone said.

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