Here we go again. Since the Chapter 9 bankruptcy filing by the city of Detroit on July 18, a lot of people have had a lot to say about the safety of the municipal bond market. I’d like to offer some context.
It’s very important to understand the size of the municipal bond market and to put Detroit in proper perspective. Consider this:
- The muni market consists of approximately 95,000 issuers with roughly $3.7 trillion of total debt outstanding.1
- Detroit’s total bonded debt is about $8 billion — $6.3 billion of which is secured by revenues or state aid.2
- Of the remainder, $530 million are general obligation bonds.2
- Bottom line: The size of the problem relative to the overall municipal bond market is very small.
While Detroit issued $1.4 billion in certificates of participation in an effort to close its pension gap,2 these are taxable securities and not the typical tax-exempt municipal obligation. (Notably, pension reform has been a common theme across the country, with 45 states enacting meaningful reform since 2009.3 More on that in a future blog.)
Are there other cities struggling with pension problems and weak economies? Absolutely. But places like Chicago, Philadelphia and Pittsburgh (often cited as troubled spots) are quite different from Detroit. Detroit has experienced unparalleled out-migration falling home values, cuts in services and the inability to attract businesses. The restructuring of the auto industry and exodus of big employers like Comerica Bank have, unfortunately, left the city with long-term structural problems. Detroit has also suffered from fraud and mismanagement, with a past mayor now serving a prison sentence. Other cities, including those I mentioned above, have strong, stable regional economies that are anchored by industries like healthcare and higher education.
The municipal market has gone through stress before. It has seen bankruptcies and defaults: New York City in the mid-1970s, Cleveland (OH) in the late 70s and early 80s, Orange County (CA) in 1994 and Jefferson County (AL) in 2011, to name a few. But defaults and bankruptcies are the exception, not the norm.
Importantly, after each of the aforementioned cases, there was no spate of filings that followed. The fact is that Chapter 9 brings with it a stigma that issuers generally will do anything to avoid. We have no reason to believe this time will be any different.
Many investors made a mistake when they exited the muni market in late 2010 and 2011. Rates were rising and headlines touted credit weakness. Spooked investors unwisely sold at exactly the wrong time, costing them a significant amount of money. We would hate to see a repeat today. As then, there’s no need to panic here.
Cities that have pension problems and municipal debt outstanding represent a small fraction of the municipal market. The broad market is high quality, with an average rating of AA.4 Revenue bonds that use specific project receipts to pay debt service comprise two-thirds of that market.
Detroit-induced headlines will create noise, but I’ve been a muni investor for a long time, and I would submit that the underlying fundamentals rise above the din and speak much louder to the strength of the broader municipal market.
1 Sources: BlackRock and Federal Reserve Statistical Release, June 2013.
2 Source: Detroit Emergency Manager’s proposal dated June 2013.
3 Sources: PEW Center and National Conference of State Legislators (NCSL), as of December 2012.
4 As represented by the quality constituents of the Barclay’s Municipal Bond Index.