Municipal bond defaults have increased in number since the start of the financial crisis, but remain extremely infrequent, says Moody's Investors Service in its annual report "US Municipal Bond Defaults and Recoveries, 1970-2012."
In the period from 1970-2007, defaults of Moody's-rated credits averaged 1.3 per year. For the 2008-12 period, however, following five new defaults in 2012, the average rose to 4.6 defaults per year.
However, the one-year default rate for Moody's-rated municipal issuers remains very low at an average of 0.030% for the last five years, compared to the 0.009% average for the 1970-2007 period and the 0.012% average over the entire 43-year period of Moody's study.
Of the five defaults in 2012, three were of Moody's-rated general government bonds. Several other local governments that Moody's does not rate also filed for bankruptcy during the year.
These numbers are small given that Moody's has approximately 16,000 U.S. public finance ratings, roughly 8,300 of which, or 53%, are on general obligation (GO) bonds.
Although downside pressure in the municipal sector may persist for some time, Moody's believes municipal defaults will remain few in number.
"Even recently increased default activity remains well within levels predicted by our present municipal rating distribution," says Anne Van Praagh, a Moody's Managing Director and Chief Credit Officer for Public Sector Ratings. "However, risks are tilted to the downside going forward."
Historically, the majority of municipal defaults-70%-have been in the healthcare and housing project finance sectors. In recent years, however, general governments began experiencing a confluence of economic, financial, and governance challenges that have been increasing the number of defaults and bankruptcies.
"Growing pension costs, increasing exposure to the capital markets and changing attitudes towards default and bankruptcies have intensified credit stress faced by local governments," says Van Praagh. "Demographic trends may further constrain some local governments' long-term flexibility, creating an environment with more downside risks and limited upside potential."
The increase in municipal government defaults is in line with the growing number of municipal governments that have speculative-grade ratings.
Historical ultimate recovery rates on defaulted U.S. municipal bonds are generally higher than those on unsecured corporate bonds, says Moody's. On average, the ultimate recovery for municipal bonds was just under 65% for the period 1970-2012, compared to 49% for corporate senior unsecured bonds over 1987-2012. However, municipal recovery rates are highly dispersed across individual bonds, ranging from full recovery to two cents on the dollar.
