Current default trends and bankruptcy events indicate that the level of recoveries from troubled municipal bond debt may be substantially lower in the future, Kroll Bond Ratings Agency said in a report Monday.

Municipalities that opted for bankruptcy are raising questions about the security of public finance and may set a precedent that leaves default and bankruptcy as more acceptable strategic options, according to the report.

“We are at an inflection point in the practice of municipal credit analysis,” Karen Daly, senior managing director at Kroll, said in an email. “What was formerly unthinkable has become a reality.”

Municipalities' decisions over the last several years to choose bankruptcy have roiled the municipal markets and challenged long-held assumptions about security in that marketplace, Kroll said in its analysis.

“Although KBRA does not anticipate widespread defaults, we believe that this change of attitude towards payment of debt represents the greatest risk to the stability of the municipal credit markets,” the report said.

The average par default rate in municipals, traditionally considered a safe bet for long-term investors, for the period from 2008 to 2012 was 0.17%, compared with a default rate from 1980 to 2012 of 0.13%, according to Kroll.

The higher rate the past four years was elevated by defaults of high profile distressed credits including Vallejo, Calif., Jefferson County, Ala., Harrisburg, Pa., Central Falls, R.I., Stockton, Calif. and San Bernardino, Calif., the report said. Detroit’s historic $8.4 billion bankruptcy filing in July represents about 0.24% of total par outstanding in the municipal market in 2012.

Special assessment, utility, transportation and industrial revenue bonds represented the largest sectors for default and accounted for 72% of overall defaults over the 2008-2012 period. General obligation bonds increased from 4% to 23% of total defaults from 2008 to 2012, according to data from Income Securities Advisors in Kroll’s report.

“The underlying cause continues to be severe fiscal stress,” the rating agency said in the report. “While the factors contributing to fiscal stress will vary with each situation, the lack of long-term fiscal planning, faltering crisis management and lack of strategic alignment, either at the municipal level or vis-à-vis the State, seem to be common themes.”

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