Default by a municipal bond issuer has been an exceedingly rare occurrence, but a number of signs suggest that the municipal bond market may be on shakier ground than anyone dreamed possible, according to a recent SmartMoney article by Russell Pearlman, “Municipal Bonds: Derailed.”
From 1974 to 2009, the default rate on “investment grade” municipal bonds was a negligible 0.3 percent. Corporate bonds defaulted five times as often. “For the most part, municipal credit is very sound,” says Jim Murphy, who oversees a $1.8 billion tax-free high-yield bond fund at T. Rowe Price. Others are not so sure.
They see bonds issued by insolvent foreign nations such as Iceland and Greece, California issuing IOUs, other local governments slashing services and defaulting on their debts in the wake of staggering revenue shortfalls. As Pearlman says, “there’s been plenty of reason for investors to feel nervous about the $3 trillion, U.S. municipal bond market.”
Since last July, 201 (mostly “lower caliber”) municipal bond issuers have missed interest payments on some $6 billion worth of bonds, as compared to 162 in 2008 and only 31 in 2007. “Already, sober-minded bond analysts and even a few state officials are beginning to join the fringe doomsayers in warning that there’s potential for a municipal bond collapse. A small but growing number of financial advisers are uneasy too, telling clients to pull back a bit.”
As one example, the article cited $600 million in municipal bonds issued to finance an automated monorail that would ferry millions of tourists up and down the famed Las Vegas Strip. The bonds were rated AAA and paid up to 7.5 percent in interest. They seemed to be “the very definition of ‘safe’ muni bonds.”
Contrary to al expectations, however, fewer tourists came to Vegas, and those who came did not use the monorail. In short, the monorail brought in far less revenue than expected, and the nonprofit monorail agency filed for bankruptcy-court protection earlier this year. According to the article, the bankruptcy attorney said the next payment – due on July 1 ? will not be made. Worse, investors could lose their principal.
Given the low interest rate environment today, municipal bonds and muni bond funds are attractive to many risk-averse retirees seeking income. A record $70 billion flowed into muni bond investments last year, according to the article. “But pile on more defaults or other troubles, say skeptics, and prices in the whole category could plummet.”
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. Page Perry’s attorneys are actively involved in counseling institutional and individual investors involving municipal securities. For further information, please contact us.