It wasn’t so long ago that the rating of municipal bonds was considered a scandal. Munis were regarded as bullet proof investments by some commentators. The idea that bond insurance on municipal bonds was a totally unnecessary measure created by consistent underrating by ratings agencies began to gain traction.
What a difference a few months can make. With the bond insurers now ailing, investors have turned to credit default swaps to protect against municipal defautls. The market for credit protection is now pricing munis as more likely to default than similarly rated investment grade corporate bonds, FT Alphaville’s Stacy-Marie Ishmael points out.
“Spreads on the MCDX , which references the CDS on 50 municipal bonds, were quoted around 330bp on Wednesday afternoon, Markit said. The CDX IG, which consists of contracts on 125 North American investment grade bond issuers, was trading around 269 bps,” Ishmael writes.
Ishmael quotes the credit analyst for Markit, which publishes the MCDX index that measure the perceived risk in muni bonds.
“The current widening of Markit MCDX spreads reflects the perceived increase in municipal credit risk. A confluence of events – an economy in recession, decreasing home values and increasing unemployment – has combined to reduce municipalities’ sources of income. Several municipalities have announced recently that they are experiencing financial difficulties. The likes of Michigan and New York City, exposed to the struggling auto and financial sectors respectively, demonstrate the importance of credit risk in the municipal market.”