If you’re looking for drama in the municipal bond market, a report by Moody’s indicates you’ll have to look elsewhere.
Muni bonds remain steady.
According to the rating agency’s annual municipal default study, defaults are rare, munis fared well during last year’s pandemic outbreak and municipal bonds are highly rated compared to corporates.
In other words, tax-free bonds continue to perform as generations of investors expect them to.
Over 51 years, muni bonds remain steady
The study covered the 51-year period from 1970 through 2020. Of particular interest was the fact that although the economy slowed abruptly, there were no virus-related defaults last year.
“Municipal defaults and bankruptcies among Moody’s-rated issuers continue to be rare, even despite the pressures faced over the past year and a half driven by the unprecedented and wide-scale shutdowns,” Moody’s said.
“Overall, the municipal sector demonstrated continued resilience, benefitting from very healthy reserves, the ability to disconnect spending from revenues, broad federal assistance, and access to liquidity and the capital markets for restructurings.”
Although the percentage of speculative grade credits has grown in recent years, municipals remain very highly rated overall with generally stable credit quality, Moody’s said.
It noted the average five-year municipal default rate since 2011 was a miniscule 0.12%. While higher than the 0.08% rate for the entire 51-year study period, it was significantly lower than the average five-year corporate default rate of 7.4% since 2011.
“Municipal ratings were relatively stable in 2020, compared to both corporates and the prior year,” the report said.
Relatively stable ratings in pandemic year
In the two years before the pandemic, muni credit quality was stabilizing, aided by growth and economic recovery in many parts of the country. Although COVID-19 slammed the brakes on growth last year, there were fewer rating changes during the year than previously.
In fact, rating volatility dipped, and there were about as many rating downgrades as there were upgrades.
As of the end of 2020, about 91% of all the munis Moody’s rates were rated A or higher. The median rating for U.S. munis fell to Aa3 compared to Aa2 in 2019. The median rating for global corporate bonds, on the other hand, was Baa3, down from Baa2 in 2019.
Of course, munis do default, as Moody’s noted, and challenges exist in “substantial increases in pension and retirement health care leverage” as well as “associated heightened exposures to equity markets.
The bigger picture, however, is particularly illuminating.
There are more than 50,000 different state and local governments and other issuers in the $3.9 trillion municipal bond market. In the more than half century covered by the study, there were only 114 Moody’s-rated defaults representing about $72 billion.
Successful investors understand the role tax-free bonds play in their portfolio and select bonds that suit their objectives. They sleep well at night knowing their interest clock keeps ticking and they’re earning a dependable stream of tax-free income.