Despite Detroit Scare, Municipal Bond ETF Credit Risk Remains Muted

ETF Trends

Some investors remain wary about municipal bond exchange traded funds after the Detroit bankruptcy fiasco and weakness in Puerto Rico’s finances. While defaults rates have picked up, they remain extremely infrequent, according to Moody’s Investors Service.

“Municipal bond defaults have increased in number since the financial crisis, but remain extremely infrequent,” Moody’s Investors Service said in the report, US Municipal Bond Defaults and Recoveries, 1970 — 2013.

Specifically, there were seven Moody’s rated defaults in 2013, following five defaults in 2012, with an average of 5 defaults per year over the 2008 to 2013 period.

“We expect municipal defaults will remain few in number,” Moody’s said in the report. “Even recently increased default activity remains well within that predicted by our present municipal rating distribution. We believe that risks are stabilizing as public finance issuers adjust to new realities.”

Last year, five of the seven munis were general government defaults, or in general obligation bonds, including the first-ever school district default and Detroit, now the largest U.S. munis bankruptcy on filing. [Detroit Bankruptcy Casts Shadow Over Muni Bond ETFs]

“More recently, general government defaults and bankruptcies have been on the rise, although these still remain few in number,” Moody’s said in the report.

Many of the largest muni bond ETFs, such as the iShares S&P National AMT-Free Muni Bond ETF (MUB) and the SPDR Nuveen Barclays Municipal Bond ETF (TFI) , are heavily allocated to general obligation (GO) bonds, or bonds that are backed by the credit and taxing ability of a city or state.

On the other hand, investors can consider the db X-Trackers Municipal Infrastructure Revenue Bond Fund (RVNU) , the first ETF to focus exclusively on revenue bonds, or those munis that are supported by revenue from projects such as toll roads or bridges. [An ETF for Lower Risk in Municipal Bond Portfolios]

The ratings agency, though, argues that general governments are stabilizing as local governments rebalance operations. However, Moody’s warns that rising pension costs pose downside risks in some cities.

Moody’s also points out that one-year default rates still remain at an average low of 0.03% for the past five years, compared to the 0.01% average for the 1970 to 2007 period. Moody’s rates approximately 15,700 municipal issuers.

“Looking ahead, our outlook for state and local governments is stable, but downside risk will persist in some places,” Al Medioli, the Moody’s Vice President, Senior Credit Officer, said in a press release. “This reflects a sluggish and uneven recovery, economic stress on households, demographic trends, and growing pension liabilities.”

For more information on the munis market, visit our municipal bonds category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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