Municipal bond default rates are low, a pleasant surprise in the wake of the coronavirus pandemic and one that highlights opportunities with the VanEck Vectors High-Yield Municipal ETF (CBOE: HYD).
Due to the economic shutdown, which led to a spike in unemployment rates across the country, plenty of states are facing budget woes. Some of those with the worst shortfalls are among the largest issuers of municipal bonds, meaning they’re also among the biggest weights in this category’s ETFs. However, to this point, the muni market is proving resilient.
“At the end of July, Moody’s Investors Service released its annual municipal bond market snapshot, US municipal bond defaults and recoveries, 1970-2019, with updates through 2019. The report continues to affirm two hallmark benefits offered by muni bonds,” notes Michael Cohick, VanEck senior ETF product manager. “First, municipal defaults and bankruptcies remain rare overall, even though they may have become more common over the last 10 years. (There were no rated municipal defaults in 2019.) Second, muni bonds continued to be highly rated in 2019, with more issuers upgraded than downgraded. (According to Moody’s, however, as in 2018, the size of the downgrades, on average, was larger than the upgrades.)”
Yields on munis have been steadily falling with bond prices rising even before the coronavirus hubbub. After the 2017 tax law changes, demand for tax-exempt munis became more attractive in response to caps in the federal deduction for state and local taxes, especially among more high-tax states. The tax law also diminished supply due to new limits on when governments can issue tax-exempt debt.
“We continue to argue that, while it remains a struggle to obtain the same amount of timely disclosure from issuers of municipal bonds as one sees in other asset classes, the pure empirical evidence suggests that muni bonds still offer a fiscally sound vehicle for deriving an income stream free from federal, and in some cases, state taxes,” writes Cohick.
When it comes to municipal bonds, fixed income investors may tend to have a home bias or look at one bond and think they’re all the same. What they might find out when they actually put these bonds under a proverbial microscope is that they can differ from one bond to the next.
“If one looks at long-term municipal bond obligations across all sectors between 1970 and 2017, according to Moody’s report, there were only 113 distinct Moody’s-rated defaults in the total amount of a little over $72 billion. There are more than 50,000 different state and local governments and other issuing authorities,” according to Cohick.
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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.