there has been only one default of a Moody’s-rated issuer. However, when expanding the view to include both rated and non-rated issuers, there were 57 issuers that defaulted in 2021 and 52 issuers in 2022, according to Bloomberg. This demonstrates the additional risk associated with nonrated municipal bonds, with most of those defaults in the healthcare and development sectors. In fact, healthcare and development bonds together have accounted for more than 70% of all municipal bond defaults each year since 2018. Issuers without tax support in the healthcare sector have had a volatile few years since the beginning of the pandemic. Margins have been pressured further by inflation and high labor costs amid a nursing shortage. Credit quality of development districts can vary widely depending on location and primary revenue sources. In some areas, commercial real estate values are depressed as the “work-from-home,” or hybrid work models, weaken demand for office space. Also, bonds issued by Tax Increment Financing (TIF) districts or other development districts may be repaid from a narrow, economically 100 % 80% 60% 40% 20% 0% States Local Governments ▪Property Taxes ▪Individual Income Taxes ▪Corporate Income Taxes ▪Sales Taxes ▪Other 33% 35% 2% 17% 5% 67% 1Tax Revenue Breakdown for State and Local Governments - Q3 2022 sensitive revenue stream. For example, TIF bonds are usually secured by a tax on an increase in the assessed valuation of that district following a project or improvement. If the value of that area remains flat or declines, revenues may not be sufficient to repay the bonds as planned. In other cases, development bonds may be secured by a tax derived from sales in a specific area, which could be disproportionately affected by an economic downturn depending on the types of businesses in the district. While past performance is no guarantee of future results, most municipalities are well-prepared for a downturn and may not even see much, if any, decline in tax revenues. However, idiosyncratic risks remain particularly within the healthcare and development sectors, and other weak credits may be further impaired by a recession. Investors should cautiously monitor holdings of these types of bonds, particularly if they are nonrated and don’t carry any additional bondholder protection. Dana Sparkman, CFA, is Senior Vice President/ Municipal Analyst in The Baker Group’s Financial Strategies Group. She manages a municipal credit database that covers more than 150,000 municipal bonds, providing clients with specific credit metrics essential in assessing municipal credit. Dana earned a bachelor’s degree in finance from the University of Central Oklahoma as well as the Chartered Financial Analyst designation. Contact: 405-415-7223 or dana@GoBaker.com. 2
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