Investors in municipal credit need to make an important distinction between rated government bodies and unrated speculative credits, analysts from Fitch Ratings said at a conference yesterday.
While Fitch expects an uptick in defaults among lower-rated and unrated municipal issues, state and local governments with taxing authority and investment-grade ratings remain reliable debtors.
“I’m not saying it’s impossible, but I think it’s fairly unlikely,” said Amy Laskey, who heads the tax-backed analysis group at Fitch, in response to a question about widespread defaults.
Fitch held its “Morning Credit Brief: Hot Topics For Investors” conference yesterday at the Grand Hyatt in New York amid a miasma of jitters about municipal credit. Articles and reports fretting over local government budgets are prevalent.
States are grappling with record declines in tax receipts, according to the Census Bureau.
An unemployment rate at 10.2% and shrinking income taxes have coincided in this recession with greater need for state services, the Center on Budget and Policy Priorities wrote in a report last week. This combination has led to “large, widespread, and persistent state budget gaps of stunning magnitude,” the report said. State budgets face an average deficit of 25% this year, the CBPP wrote.
Also last week, the Pew Center on the States issued a report declaring California, Arizona, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island, and Wisconsin in “fiscal peril,” based on certain measures such as unemployment and foreclosure rates.
Perhaps they are in fiscal peril, said Richard Raphael, head of the public finance group at Fitch, but financial peril is a gulf away from default.
“We have to distinguish this from widespread defaults and bankruptcies from governments, which we expect will remain low,” he said.
State and local governments continue to honor their commitments to repaying debt, the Fitch analysts said.
Further, the alternative to repayment of bonds is ugly, according to Raphael.
Even when local governments are permitted to file for Chapter 9 bankruptcy protection, they are not accorded an easy way out of their troubles, he said.
Proceedings are laborious and municipalities that default would lose access to the bond market for some time, Raphael said.
Few municipalities would opt for bankruptcy given the choice, he said, pointing out that the proceedings for Vallejo, Calif., likely do not seem tempting to other cities.
Raphael expects to see more defaults in land-backed deals in states like Florida, Arizona, Nevada, and California.
Thirty-three land-development districts in Florida committed payment defaults last week, according to Municipal Market Advisors.
Most of the deals likely to default are unrated and poorly collateralized, Raphael said. The newest deals are at the greatest risk because they tend to have weaker credit characteristics, he said.
The questions asked at the conference reflected the prevailing worries over municipal credit.
One questioner said he thought California was “toast,” and argued it should be rated low junk inasmuch as the state already reneged on payments to low-priority creditors earlier this year by issuing IOUs.
Another asked what would happen if several high-profile municipal bankruptcies erased the stigma of default, rendering defaults “the norm.”
The questioner acknowledged this was a remote risk.
In the past 10 years, defaults have been negligible on municipal credits rated higher than BB by Fitch, and only peek above 10% at the CCC level.