The Dreaded “D” Word
- Wednesday, 03/14/2012
- Default has different meaning for municipals
- Who is the authority on muni defaults?
- Perception of rising muni defaults is not the reality
We have seen and heard the term default brought into play for the municipal bond market in a significant way over the past 18 months, but never more so than in the six months subsequent to Meredith Whitney's pronouncements from her December 19, 2011 appearance on 60 Minutes. Sparing the details, her suggestions sent the municipal market into a tailspin during the first half of 2011. What she did not make clear was the all-important distinction between the terms "default" and "bankruptcy" as they apply to municipal bonds. In the muni universe, these terms have significantly different meanings than in the corporate world. While corporate defaults conjure images of layoffs and restructuring, municipal defaults can — and often do — mean a failure of an issuer or obligor to meet certain terms of the controlling operating documents. Most often, it requires and spells out a remedy. But it doesn't necessarily mean non-payment.
What, then, is the average investor to believe when reading headlines speaking of defaults and bankruptcies in the muni space? The ratings agencies (Moody's Investors Service and Standard & Poor's) have each periodically produced studies of these events, but they generally limit their activities to issues they have rated. Other analyses come from advisors and market professionals who glean details from many sources to produce broader studies. There is, however, no single "go to" authority for a universally accepted evaluation. To generalize from all information available, we can conclude that the combination of default and bankruptcies in the municipal market has been exceeded in the corporate market by a factor of approximately three to one. (Based on historical data from 1980 through the present.)
The perception that there is danger in the municipal market because of a rising number of defaults often ignores the reality that bondholders are still being paid their coupons and that remedies often set the course for a cure. Still, non-payments may occur — and they demonstrate that certain risks inhabit the world of municipals, but, we would argue, usually at a far lower rate and severity than in the taxable universe.