Analysts, Bankers and Buyers Remain Upbeat on Muni Credit

Harrisburg, Pa.’s near-miss on its general obligation debt, Warren Buffett’s gloomy foreshadowing of a “terrible problem,” and flirtations with a double-dip recession have not much changed the tenor of analysts’ expectations for the strength of municipal credit.

Analysts, bankers and investors at the Bloomberg Cities & Debt Briefing in New York City on Wednesday continued to express a reserved optimism about how dependably state and local governments will repay their debts.

The general tone, which has persisted since the financial crisis, is that municipal governments face elevated stress likely to lead to only a minor increase in defaults.

“We think that the sector is resilient; the default rates are going to be low,” said Robert Kurtter, managing director for U.S. state and regional ratings at Moody’s Investors Service. The default rate on rated munis since 1970 is well under 1%, Moody’s says. Only three general obligation credits have defaulted in that time.

John Hallacy, head of municipal research at Bank of America Merrill Lynch, pointed out that despite the pressures facing governments, the bond market remains very receptive to municipal debt.

Yields remain near historic lows and many deals are oversubscribed, he noted.

“In some respects the credit challenges have never been greater and yet the market tone is quite good,” Hallacy said. “We’ve been through many crises before in the municipal industry. Usually what we do is refund, restructure, delay, and defer” until the economy recovers.

The problem this time around is that the recession has persisted for so long, he said. State and local government tax receipts shrank 5.8% last year, according to the Census Bureau.

As of July, states faced a combined budget gap of $83 billion for the current fiscal year, according to the National Conference of State Legislatures.

Kurtter acknowledged the risks would become more severe in the event of a double-dip recession. During a panel titled “Is California America’s Greece?” Dick Larkin, director of credit analysis at Herbert J. Sims, was asked that very question. His answer was one word: “No.”

He drew a distinction between governments forced to cut spending or raise taxes because they face deficits and governments that fail to meet debt service. California’s $19 billion budget gap falls into the former category, he said. “I think they’ll do what has to be done to pay the debt,” he said. “Will it be easy? Absolutely not.”

When asked to forecast a likelihood California will default, Larkin said 2%. It likely would probably be a clerical error, he said, meaning forgetting to appropriate cash to the right fund or agency and missing debt service by a few days.

Chriss Street, treasurer-tax collector for Orange County, Calif., was more pessimistic. He pegged the likelihood at 5% or 6%.

Street pointed to a potential culprit: California has a tiered system for payment priorities, with bondholders near the top. However, if the state fails to pay a vendor in a lower tier one year, it commits to paying him first the next year. That would put the vendor senior to interest payments on debt, Street said, which in a scenario of tight cash might imperil interest repayment.

“I think this is a real issue, and I don’t think the principal defaults but you could have some kind of workout on the interest,” Street said.

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