Study finds non-GO bond defaults don't impact GO ratings

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Unrated and uninsured non-general obligation bonds defaulted 10 times more frequently than general obligation bonds with credit ratings between 2009 and 2015.

But the impact of the defaults of the non-GO bonds was negligible to nonexistent on the ratings of GO bonds issued by the same local governments.

That’s among the findings in new academic research by Lang “Kate” Yang of George Washington University’s Trachtenberg School of Public Policy and Administration and co-author Yulianti Abbas of the School of Economics at Universitas Indonesia.

Yang, an assistant professor from George Washington University, said the findings serve as a warning to state and local governments to not use their general fund money for bailouts of non-GO debt.

“I am biased in that I care a lot about issuers, state and local governments themselves,” Yang said in an interview. “So I want them to make policies based on evidence and this evidence is telling them not to bail out their non-GO credit. At least to not use their general fund money to service other credit simply because of concern about the effect on their future borrowing costs, because we didn’t find evidence of that.”

Yang was scheduled to deliver her findings Monday at the annual Brookings Municipal Finance Conference in Washington.

The study by Yang and Abbas is the first academic look at unrated and uninsured non-GO bonds.

“Overall speaking, I think this is good news,” Yang said. “The market is behaving pretty much in the way that we know.”

The paper cited a 2015 study by Moody’s which reported that defaults were rare but there’s a fragile budgetary balance for many local governments.

"Most of the defaults happen on unrated bonds," Yang said. "We uncovered more only because we covered a larger field. Not because the propensity of a given bond is higher.”

The researchers did not study bonds issued by special taxing districts.

But they did include bonds issued by conduit issuers and departments within a municipal government.

They also excluded the bankruptcies filed by Puerto Rico, Detroit and Jefferson County, Alabama, from their study.

But they noted most defaults on GO bonds have resulted in bankruptcy filings by municipalities.

They also broke new ground by dividing defaults into three categories based on their severity.

Technical defaults were considered to be a “failure to comply with provisions of the bond indenture that are not directly related to paying interest and principal.”

Pre-monetary defaults involved unscheduled draws on debt service reserves and backup credits.

The most severe default was categorized as a “monetary default” because of a failure to pay interest or principal.

The researchers found the first two categories of default to be the most common.

In each of the three categories of default, the ratio of unrated and uninsured bond defaults was about 10 times higher than for rated GO bonds.

The data for the survey came from the EMMA database of the Municipal Securities Rulemaking Board.

Yang said the study did not consider years prior to 2009 because that’s when EMMA began posting the event notices that were used in the research.

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General obligation bonds Tax-exempt bonds State and local finance Bond defaults Washington DC