First-time municipal payment defaults and “impairments” are up through the third quarter this year compared to the same period last year, reversing a 10-year trend, according to Municipal Market Analytics.
First-time issuer defaults are up 19% to 37 through the third quarter compared to the same period last year. That excludes Puerto Rico which is going through bankruptcy-like proceedings.
First-time impairments, which include defaults, are up 30% to 108 through the third quarter compared to the same time last year.
Total ongoing impairments being reported were at 671 for the first three quarters, up 11% from last year, according to the data MMA tracks, drawn primarily from the Municipal Securities Rulemaking Board’s EMMA website.
The 108 impairments show “the most new trouble developing among municipal issuers since 2015” when 131 new impairments were disclosed before Oct. 1, MMA noted.
About 41% of the newly-reported troubles came from bonds issued in the last three years, said MMA partner Matt Fabian.
Rather than signaling that turbulence in the credit cycle may be afoot, Fabian suspects the market environment and rising demand for high-yielding paper in recent years is behind the troubles.
“Demand is mostly driving it. There’s such a demand for high-yields that it’s pulling these bonds into the municipal market,” Fabian said. “The new issue calendar has had a larger number of speculative financings in the last three to five years and because there’s so much demand for high-yield it’s encouraging underwriters” to bring the deals.
With rates also remaining so low for a sustained period, some issuers may be persuaded to act sooner rather than later — before a project or financing is fully vetted for its feasibility — rather than risk missing out on the low rates.
The low rates combined with demand means some more speculative deals that might previously have been the subject of direct or private placements are now publicly offered, Fabian said. “Some deals are maybe not quite ready for prime time,” Fabian said. Such strong demand for the yield offered by riskier paper also can result in weakened security features such as covenant tests or reserve cushions.
“The numbers are higher but not that much higher to a level where investors will become more conservative in how they allocate their dollars” and “they are too small” still to read into them a shift downward in the credit cycle, Fabian said.
But they are concerning and do bear watching, Fabian said. “When the credit cycle does turn, defaults will go higher,” he added.
MMA launched its default/impairment tracking system 10 years ago in part to judge whether in fact those credits generally considered safer higher-grade investments remained so and Fabian believes the numbers bear that theory out.
“When we started out it was not to track the riskier stuff, it was to verify that the safe bonds, year to year, remained safe,” and that mostly remains the case, Fabian said.
MMA puts payment defaults into the broader impairment category along with a series of other situations that include “support” needed to make the payment. That’s defined as borrowers covering payments through draws from reserves or bond insurance coverage.
Another category labeled “other” is included in impairments and it’s more broad and subjective. It includes situations where covenant violations or technical defaults have occurred. The disclosure of serious problems that signal the potential for a future payment default are also lumped into the category.
Puerto Rico defaults and impairments are not included because they skewer the data for comparison purposes, Fabian said.
The principal sector trend shows an increase in multifamily housing defaults, eight compared to just two last year, but otherwise there’s been roughly the same number of defaults by senior living projects, charter schools, and hospitals.
“Also we note a more typical 12 different sectors providing defaults this year versus just nine last year,” the report said. “On average, payment defaults have occurred in 15 different sectors in each of the last ten years.”
Impairments are not concentrated in any one sector. The three sectors with the most impairments this year are senior living, land-secured, and local general obligation deals, representing 46% of impairments. That’s a little less than what the three biggest sectors typically provide.
The 10 troubled GO bond issues exceed any full-year count for GOs in the last decade, the report noted. “In MMA’s view, it remains too early (and the raw numbers are still too small for such a large universe of credits) to consider this a reliably negative trend for GO bonds in general,” according to the report.
Defaults have occurred this year in 22 states while 31 states saw municipal borrowers disclosing their first impairment this year.
In 2010, MMA’s first year of tracking defaults and impairment, the year ended with 149 defaults and 340 impairments.