Municipal bond expert Robert Doty says the risk of default for municipal bonds is concentrated in those that are dependent on private profit or nonprofit institutions’ performance.
“Pundits, many market participants and even regulators have missed significantly higher risks of specific sectors readily identifiable in advance,” Doty wrote in a paper provided to The Bond Buyer. Doty is president of AGFS, a consultant on municipal bonds.
Doty pointed to a Weekly Outlook released in February by Municipal Market Advisors that studied default rates by sector.
Looking at outstanding bonds by CUSIPs, two of the seven sectors with the highest default rates were connected with housing — community development districts, with a 16.56% rate, and local multifamily housing, with a 1.61% rate.
Additionally, four were connected with senior care — assisted living, with a 4.48% rate, independent living facilities, with a 4.19% rate, nursing homes, with a 3.31% rate, and continuing-care retirement communities, with a 2.13% rate.
The final sector in the top seven was telecommunications, with a 3.29% rate.
By comparison, traditional government general obligation bonds were defaulting at a 0.01% rate. Water and sewer bonds had a 0.02% default rate.
“The following are guideposts to risks: securities involving significant private participation, securities to fund infrastructure for real estate, securities payable from startup or rapidly expanding projects, securities of issuers involved heavily with exotic instruments, annual appropriation securities for nonessential projects [and] unrated securities,” Doty wrote.
As examples of exotic instruments, Doty mentioned interest rate swaps used by Jefferson County, Ala., and collateralized debt obligations used by five Wisconsin school districts that defaulted.
Investors should not necessarily avoid bonds in the risky sectors, Doty said, adding: “There should be greater care exercised with the bonds.”
A more comprehensive version of Doty’s views can be found in a paper, “Will Fiscal Stress Cause Widespread Municipal Defaults?” posted on the website www.agfs.com.
Recently, Bloomberg Press published Doty’s book, “Bloomberg Visual Guide to Municipal Bonds.”
A March study by Moody’s Investors Service, “U.S. Municipal Bond Defaults and Recoveries, 1970-2011,” came to similar conclusions as Doty and Municipal Market Advisors.
The Moody’s study only counted actual defaults leading to changes in the timing or amount of payments, not technical defaults. It also did not count delayed payments made within contractually allowed grace periods.
Looking at defaults using 10-year periods beginning in 1970 through 2011, Moody’s reported that 0.01% of GOs defaulted. Looking at the same period and same course, 0.30% of non-GOs defaulted.
“Enterprise risk remains the common theme among defaulters,” the Moody’s analysts wrote.
“Most rated defaults occurred in the health care and multifamily sectors, which together account for just under 70% of all events of [muni] default,” the analysts said. “The combined principal amount of debt affected, however, was just 5% of the total in the record.”
The common theme in the health care and multifamily housing sectors for bond defaults was “failure to compete successfully in a local market, whether hospital or apartment rental.”
“A similar pattern is present among the six defaults in the transportation sector … and among commercial real estate projects. … Actual utilization and revenue in five of the project financings fell well short of the original forecasts.”