A growing number of U.S. cities are choosing to fund essential services like public safety and garbage collection over making payments on their outstanding debt, as rising costs and falling revenue deplete their budgets.
So far, the bond defaults are not roiling the $3.7 trillion municipal market because insurance companies are stepping in to make payments to bond holders in some cases. But defaults on insured bonds are putting pressure on these insurers, which never fully recovered from the last decade’s financial crisis.
The California cities of Stockton and Hercules, as well as Pennsylvania’s capital, Harrisburg, have opted to default on some of their insured debt in recent months.
“Municipalities are saying this is what bond insurance is for – bond holders get paid,” said Richard Lehmann, publisher of Distressed Debt Securities Newsletter.
So far in 2012, there have been 21 muni defaults totaling $978 million, versus 28 defaults totaling $522 million for the same period in 2011, said Lehmann, who sees the number rising. A breakdown of defaults on insured munis was not available.
Although issuers contend they are not singling out insured munis for defaults, some believe that municipalities are strategically protecting bond buyers by relying on insurers to pay the debt service.
“Such a default may signal changing attitudes by distressed municipalities to contemplate a strategic default or bankruptcy on insured debt, knowing that bond holders will not suffer losses,” Moody’s Investors Service said in a report this week.
The credit rating agency added that municipal issuers “may be willing to damage their relationship” with insurers, which in turn could potentially be exposed to large losses.
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