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US Municipal Bond Defaults and Recoveries, 1970-2019

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US Municipal Bond Defaults and Recoveries, 1970-2019 U.S. PUBLIC FINANCE DATA REPORT US Public Finance 15 July 2020 US municipal bond defaults and recoveries, 1970-2019 TABLE OF CONTENTS This study updates our findings concerning the default, loss and rating transition of Moody’s- Introduction 2 rated US municipal bond issuers in 2019, as well as since 1970. Key findings include: Emerging trends 2 Default rates 10 » There were no new rated municipal defaults in 2019, as the municipal sector broadly Ratings stability 15 enjoyed the benefits of a strong national economy and historically low unemployment. Ratings accuracy 22 The recoveries and related court decisions from ongoing defaults in Puerto Rico have Recovery rates 24 slowed since mid 2019, but overall continue to reinforce the trends we have previously Appendices 31 identified, including a possible new trend of selective debt repudiation. Appendix A: Overview of rated public finance sector 31 » Two defaults to date in 2020 but not virus driven. The shutdowns in response to Appendix B: Additional cumulative the coronavirus have created an unprecedented global economic shock, but we continue default rates (CDR) analysis 34 to foresee no defaults among rated municipal issuers as a direct result. Separately, the Archdiocese of New Orleans (Caa1 negative) filed for pre-emptive bankruptcy on May 1, Contacts and the process led to a July 1 payment default, while the Virgin Islands Water and Power Alfred Medioli +1.212.553.4173 Authority (Caa2 negative) defaulted by way of a forced extension of an unrated BAN Senior Vice President/Mgr/RPO maturity, deemed a distressed exchange and default by Moody's definition. [email protected] » Municipal defaults and bankruptcies have become more common in the last Sarah Jensen +1.214.979.6846 AVP-Analyst decade but are still rare overall. The average five-year municipal default rate since [email protected] 2010 was 0.13%, compared to 0.08% for the entire study period. In contrast, the average Varun Agarwal +1.212.553.4899 five-year global corporate default rate was 6.3% since 2010 and 6.7% since 1970. The VP-Sr Credit Officer average rating of municipal issuers is much higher than the average rating of corporates. [email protected] » Fewer ratings changed in 2019 compared to 2018. Rating volatility fell to 7.8 notches Kumar Kanthan +1.212.553.1428 Senior Vice President/Mgr/CSR per 100 credits in 2019 from 8.6 notches per 100 credits in 2018. Compared to rating [email protected] volatility for global corporates, rating volatility for municipals has been significantly lower. Daniel Gates +1.212.553.7923 In 2019, rating upgrades outpaced rating downgrades, but through the first half of 2020, MD-Gbl Rtgs&Process Oversight rating drift has been close to zero. [email protected] » Municipal ratings have successfully differentiated defaulters from non-defaulters. Simon Simoski +1.212.553.3653 Associate Analyst Over the study period, the three-year average defaulter position was 93.9% for [email protected] municipals compared to 87.8% for global corporates. The five-year average defaulter Kuan-Heng Chen +1.212.553.2162 position was 92.2% for municipals and 86% for global corporates. Associate Analyst/MDG [email protected] » Municipal credits continue to remain highly rated since the recalibration to Moody's global long-term rating scale in 2010. Cumulative default rates by rating CLIENT SERVICES category for municipals and corporates have been comparable since recalibration. Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE A data supplement, US municipal bond defaults and recoveries, 1970-2019 - Excel supplement, was published along with this study. Introduction This study analyzes the performance of Moody's municipal ratings and their consistency with ratings for global corporates (which include both non-financial corporates and financial institutions). It covers public underlying ratings for all public finance issuers, including US state and local governments, municipal utilities, not-for-profit hospitals, housing agencies, colleges and universities, as well as other municipal issuers with long-term debt ratings. It also includes certain municipal infrastructure and project finance credits that are tracked in parallel in our infrastructure default study. Default rates that incorporate the better of an obligor's underlying and enhanced ratings are presented in Appendix B. Insured and letter of credit-backed ratings are excluded from the study. Although the US public finance sector is notable for infrequent defaults and extraordinary stability throughout the study period, it is evolving in fundamental ways, as we have observed in our series of annual default studies since 2013. The once-comfortable aphorism that “munis do not default” is no longer credible: rating volatility, rating transition rates and cumulative default rates (CDR) have all increased since 2010, though they had begun to stabilize before the current virus-related stresses. Moreover, there is a growing awareness that legal security, while important in recovery, is a weak shield against default when credit fundamentals are poor. More recent challenges confronting the sector are substantial increases in pension and retirement healthcare leverage, and the associated heightened exposures to equity markets and demographic shifts. The growth of total leverage is significant and in stark contrast to the earlier decades of low bonded debt and long-term economic expansion. The recoveries and related court cases emerging from Puerto Rico have broadly confirmed the sectoral changes afoot. The past lessons for default and recovery – the liquidity-driven and relatively short-lived defaults of the Great Depression, in contrast to the debt-driven defaults and repudiations of state debt from the 1840s – are sobering.1 Ultimately, the character of public finance going forward will be shaped by the sector's ability to accommodate these new challengesgiven its long-standing tendency to defer or defuse risk and otherwise preserve market access, while continuing to function. Nearly every one of the crises that the municipal sector has undergone, whether before or after 1970, are different in causation and character; the sector is now enduring a very unique set of stresses stemming from the virus-related shutdowns. An important observation from the 50-year study period covered by this report is that any one default may only reflect the idiosyncrasies of that individual credit, and not be representative of any general sector trend. This particularly applies to the long period up to 2008, during which general government defaults were exceedingly rare. Other observed defaults may be tightly clustered with credit events within a specific subsector that have common underlying drivers, such as the elevated incidence of multi-family housing defaults between 2003 and 2008. Broader default patterns may emerge as a subsector’s risk profile shifts, driven, for example, by changes in consumer preferences or remote office work. Emerging trends No new municipal defaults in 2019. While there were no new rated defaults in 2019, we continue to see notable developments concerning default, bankruptcy and recovery. The California Statewide Communities Development Authority pension obligation bond pool financing 2007 Series A-2 (Caa2 positive) is unusual for severe credit stress following a natural disaster but has continued to avert default. The small town of Paradise is the pool financing's largest participant, whose share is currently 40%. The town suffered near complete destruction and substantial loss of life in the late 2018 wildfires. Nevertheless, Paradise was able to make its scheduled bond payment deposit due August 1, 2019 through insurance settlements and state backfill of lost property tax revenue, avoiding a default and ensuring a June 2020 bond payment. As a result, there continue to be no rated defaults due to natural disasters. Paradise so far demonstrates that willingness to repay debt can overcome many obstacles, including, in this case, very small scale and near total destruction. While multiple Commonwealth of Puerto Rico (Ca negative) entities remain in default in 2019, there have been no new defaults; notably, several of the Commonwealth's distressed entities have not defaulted, most prominently the University of Puerto Rico (C negative) and the Puerto Rico Aqueduct & Sewer Authority (PRASA water/sewer enterprise; Ca negative) which may well be restructured before any current payment default occurs. Puerto Rico, although a US Territory, reinforces one pattern we have seen elsewhere, which is that a bankruptcy or bankruptcy-like proceeding may not only affect recoveries differently across separate debt 2 15 July 2020 US Public Finance: US municipal bond defaults and recoveries, 1970-2019 MOODY'S INVESTORS SERVICE U.S. PUBLIC FINANCE classes but may simply not impair all debt classes to begin with. A key decision on the relative status of general obligation debt, which is also the subject of a repudiation effort, is still forthcoming. 2020: Black Swan or Pink Flamingo? Earlier editions of our annual report advanced the concept of a “new normal” for public finance given the conditions that lingered from the preceding 2009 financial crisis. Despite the persisting changed expectations about default, including recovery and the relative importance of legal pledges, and the still growing burden of defined benefit pensions, high fixed cost charges and asset market risk, there has been one very significant change: economic growth rebounded from the anemic 1-2% earlier in the decade, bringing with it a radical and even historic drop in unemployment. This growth has underlaid the strong performance of Moody’s-rated municipal issuers in the past two years, which not only have seen no defaults but broadly have managed to rebuild reserves. This trend largely explains why a number of state ratings have either been upgraded or changed to positive outlooks in the year leading into Q1 2020.
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