Municipal Defaults Are Likely to Remain Rare Events, Fitch Reports

Fitch Ratings expects municipal defaults to remain isolated events, according to a report the rating agency plans to release today.

In response to questions from new municipal investors, especially those ­interested in Build America Bonds, Fitch is publishing a statement ­explaining its expectations for defaults in the state and local government sector.

Its conclusion: “While the incidence of default may increase from exceedingly low historical levels, defaults will continue to be isolated situations.”

The underpinnings of investment-grade muni default rates — as low as 0.04% over the past 10 years — are still mostly in place, despite heavy stress on municipal budgets.

Fitch listed several bondholder protections it expects to control municipal defaults.

The cost of repaying debt is small in the context of total spending. In 2008, according to the Census Bureau, state and local governments spent about $2.8 trillion, and less than 4% of it was paying interest on debt.

Debt-service costs are generally less than 10% of municipal spending, Fitch said, and debt burdens are usually small relative to the tax bases supporting those burdens.

Most municipalities by law have to balance their budgets, restraining deficit spending.

They also generally space debt-service costs out evenly, meaning they do not have bullet maturities they need to refinance.

States will generally address a local government’s fiscal stress well before it approaches default, Fitch said, “providing a buffer between financial strain and default.”

“There have been a lot of new investors in the muni market, and we do get these questions,” said Richard Raphael, an analyst in the public finance group at Fitch.

“Those that aren’t familiar with some of the inherent protections in this market may not be as clear. There’s been a bit of sensationalism — but basically exaggeration.”

Fitch also addresses municipalities’ pension liabilities with less hysteria than the mainstream press.

While “pensions clearly represent a growing spending pressure” that “for some constitutes a major credit issue,” governments have years to address them.

Municipal governments will have to adjust their plan benefits and contributions, and in some cases they already are doing so, Fitch says. At any rate, they have years to implement these changes.

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