By Michael Cohick, Senior ETF Project Manager, VanEck.
In early July, Moody’s Investors Service released its annual snapshot of the municipal bond market, US Municipal Bond Defaults and Recoveries, 1970-2020, with updates through 2020. In addition to highlighting their resilience to COVID-19 (“Covid”) pandemic, the report continues to assert two characteristic advantages offered by municipal bonds. First, while they may have become more common in the past 10 years, defaults and municipal bankruptcies are still scarce overall. (Indeed, during the period of significant market tension in 2020 resulting from Covid, there were only two municipal defaults and none related to the virus.) Second, municipal bonds continue to be highly rated relative to corporations. While there were downgrades in municipal ratings during the year, downgrades in global corporate ratings s were more common.
Once again, an important “observation” noted in this year’s report was that over the 50-year study period: “[A]A single default may only reflect the peculiarities of that individual credit and may not be representative of a general industry trend.
Regarding the pandemic, Moody’s notes that the municipal market has experienced “a very unique set of stresses resulting from closures related to the virus, and [that] these have unleashed a series of new dynamics that will shape municipal finances in the future. These include the “rapid acceleration” of distance learning and working and, associated with these, the remoteness from high density jobs and life.
Muni Bond defaults and bankruptcies remain rare
The report drew attention, once again, to the fundamental difference between municipal and corporate credits.
The cumulative default rate (CDR) of all five-year rated municipal bonds throughout the study period (1970-2020) has remained unchanged at 0.08% and still remains very low. Likewise compared to the five-year CDR of 6.89% for global companies over the same period. Of the two municipal defaults in 2020, one was rated and the other “by an entity rated by Moody’s, albeit on an unrated instrument”.
Regarding the only default noted by Moody’s, triggered in early May by the bankruptcy of the Archdiocese of New Orleans, the report noted that the filing, seemingly preventive and defensive, illustrated a new trend, along with other examples of such actions. by nearly 20% of all Catholic dioceses in the United States, the utility PG&E and the Boy Scouts of America.
With respect to Puerto Rico, Moody’s continued to note in its report: “Puerto Rico, although being an American territory, reinforces a trend that we have observed elsewhere, namely that a bankruptcy or similar proceeding. bankruptcy can not only affect collections differently from country to country. separate debt categories, but also may not hurt all debt categories to begin with. In other words, these procedures can affect the categories of debt differently with different levels of severity.
Stable odds despite the coronavirus crisis
In the two years leading up to the pandemic, stabilizing credit quality in the municipal bond industry had been aided by economic growth and recovery in many parts of the United States. , not only were there fewer rating changes during the year than in previous years, but rating volatility also decreased. In addition, “rating downgrades were essentially equivalent to rating upgrades”.
Municipal credits remain strong and, according to the report, “their rating distribution is significantly skewed towards the investment grade, where ratings tend to be more stable.”
The report added that the municipal sector as a whole remains highly rated, with around 91% of all Moody’s municipal lending rates falling to Category A or higher by the end of 2020 (2019: ≈92%). In addition, by the end of 2020, the median US municipal credit score had only fallen to Aa3 (2019: Aa2). This still contrasted sharply with the median rating of global companies, which was Baa3 (2019: Baa2).
We continue to assert that while it remains difficult to obtain the same amount of timely information from municipal bond issuers as in other asset classes, we believe that the empirical evidence pure suggests that municipal bonds still offer a fiscally sound vehicle for deriving a stream of income exempt from federal and, in some cases, state taxes. We believe that looking at the behavior of the municipal market during the Covid crisis in 2020 is enough to get prima facie evidence of its “strength” and resilience (and municipal bonds).
Looking at long-term municipal bonds, across all sectors, between 1970 and 2020, according to the Moody’s report, there were only 114 separate defaults rated by Moody’s, representing just over $ 72 billion. dollars, from a universe of over 50,000 different state and local governments and other issuing authorities. However, as always, there are caveats. As Moody’s states once again in the report’s introduction: “The once-comfortable aphorism that ‘munis don’t default’ is no longer credible: rating volatility, rating transition rates and rates. Cumulative Defects (CDRs) have all increased since 2010. ”However, even when under stress from the virus, they have remained surprisingly stable so far.
The challenges facing this sector include demographic changes (aging and relocated populations – affecting tax revenues), “substantial increases in the leverage on pensions and retirement health care” and “exposures increases associated with the stock markets ”. In addition to these challenges, it remains to be seen what the full effects will be of the new dynamic that has only become all too apparent with the arrival and devastation caused by Covid.
Despite this, we still believe that municipal bonds remain important to the basic strategy of building an individual portfolio.
Learn more about VanEck’s lineup of municipal bond ETFs.
Originally posted by VanEck on Aug 31, 2021.
Source: Moody’s Investors Service: Defaults and Collections of U.S. Municipal Bonds, 1970-2020
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