Meredith Whitney 'not even close' as muni defaults down 60%

So far, star analyst's prediction of disaster for tax-exempt sector way off the mark; others made similar forecasts

Jul 19, 2011 @ 8:13 am

Time is running out on the credibility of Meredith Whitney, who has yet to acknowledge that her eight-month-old prediction of widespread defaults this year in the market for state and local government debt is proving unfounded.

Defaults fell 60 percent in the first half of 2011 compared with the same period last year, including a $12.5 million Austin, Texas, apartment project that made a late payment in June, according to Distressed Debt Securities Newsletter.

Whitney, the analyst who rose to prominence by predicting Citigroup Inc.’s 2008 dividend cut, predicted “hundreds of billions of dollars” of municipal defaults within 12 months in a Dec. 19 “60 Minutes” broadcast, fueling a wave of selling in the $2.9 trillion market. Instead, the number has fallen as cities slashed spending to balance budgets and state lawmakers stepped in to guard against insolvency and local bankruptcies.

“The data is not helping Meredith,” said Matt Fabian, a managing director at Municipal Market Advisors, a financial- research company based in Concord, Massachusetts. “It’s always been a possibility there would be a wave of defaults. You can’t say that it’s zero but it’s given no sign of starting.”

From January through June, defaults fell to 24 totaling $746 million, according to the newsletter from Miami Lakes, Florida-based Income Securities Advisor. That compares with 60 in the first half of last year, totaling $2.29 billion, and 144 in the first six months of 2009, at $4.89 billion.

‘Dirt-Bond’ Bubble

The failure of property developments financed with tax- exempt debt led to a record $8.15 billion of municipal defaults in 2008, the middle of the 18-month recession that ended in 2009, and accounts for the slowing pace, according to Jack Colombo, who edits Distressed Debt newsletter. There are simply fewer of the so-called dirt bonds left to falter, he said.

Jefferson County, Alabama, was the last local government to trigger a default, when it couldn’t meet payments on about $3 billion of securities tied to a sewer system in 2008 after the complex financing unraveled, he said. The county is home to Birmingham, the state’s biggest city.

Communities such as Georgia’s DeKalb County have sought to cope with financial stress by raising local taxes, while in municipalities such as Newark, New Jersey’s biggest city, mayors have slashed jobs to cut costs. In some cases, such as New York and Pennsylvania, state governments have intervened to prevent fiscal meltdowns at the local level.

Standard & Poor’s counted 28 municipal-market defaults totaling $511 million in the first six months of 2011, compared with 53 totaling about $1.55 billion in the first half of last year, according to a report from the New York-based credit- rating company.

‘Not Even Close’

“The facts just aren’t supporting” Whitney’s forecast, said J.R. Rieger, vice president of fixed-income indexes at S&P. “They’re not even close.”

Whitney, 41, who started New York-based Meredith Whitney Advisory Group LLC in 2009 after leaving Oppenheimer & Co., predicted 50 to 100 “sizable” municipal defaults as states slashed spending, in the interview with CBS Corp.’s “60 Minutes.” As for timing, she said it would be “something to worry about within the next 12 months.”

“There’s absolutely nothing about our thesis that has changed,” she said on July 12 in an interview with Tom Keene on Bloomberg Radio’s “Bloomberg Surveillance” show in New York. “There are not enough revenues to go around and service all of the debt obligations or debt commitments outstanding.”

Whitney also sought to amend her prediction in the radio interview, saying that she said in December “you’d start to see defaults within 12 months.” She didn’t respond to telephone calls and e-mails seeking additional comment.

Rare Events

Municipal defaults are rare. Moody’s Investors Service said in a study released in February 2010 that the 10-year average cumulative rate in the municipal market was 0.09 percent from 1970 to 2009 for the securities it ranks, compared with 11.06 percent for corporate debt. Most were concentrated among nonprofit health-care and housing projects. Just three were general-obligation bonds, out of 54 in all, Moody’s said.

U.S. Bank National Association, the trustee for Austin’s Rutland Place Apartments project, made a partial payment of about $150,000 last month, according to a regulatory filing. The payment was on debt issued in 1998 to mature in 2033 with a 6.5 percent coupon, according to the Distressed Debt newsletter.

Moody’s said in January that no state and only a few local governments would default this year on debt it rated, after none did in 2010.

“A locality is going to lay off a teacher before they default on their bonds,” said Iris J. Lav, a senior adviser at the Center on Budget and Policy Priorities, a nonprofit research group in Washington. “There are other things they can do.”

Falling Spending

State and local-government spending declined at a 3.3 percent annual pace in the first three months of this year, according to a U.S. Commerce Department report in April. It was the steepest drop since a 3.8 percent tumble in the same quarter last year, and the second-most since a 7.4 percent drop in the three months ending in June 1981, the figures showed.

States and localities have cut more than 580,000 jobs since payrolls peaked in 2008, according to U.S. Labor Department data compiled by Bloomberg.

Municipalities are also seeking new revenue as tax collections lag behind fiscal 2008 levels and state aid is slashed. In suburban Atlanta, DeKalb officials this week increased the property-tax rate 26 percent to rebuild the county’s finances after losing its Standard & Poor’s bond rating in March.

Cash Levels

“We’re not at the point where cash levels for most governments are so weak that there’s a tradeoff between running the essential services and making debt-service payments,” said Richard Ciccarone, a managing director at McDonnell Investment Management LLC in Oak Brook, Illinois. The company manages more than $7 billion of municipal debt.

State intervention in Pennsylvania, through a mechanism called Act 47, has given cities on the verge of insolvency an alternative way to resolve fiscal difficulties. In Harrisburg, where the City Council voted to prepare for a bankruptcy filing last month, state lawmakers crafted legislation to suspend aid for the municipality should it seek court protection.

New York put suburban Nassau County, one of the nation’s wealthiest, under control of an oversight board after finding that its budget was in deficit. Michigan enacted a law this year giving state-appointed fiscal managers the power to take control of financially stressed local governments.

Small Part

States from Wisconsin to Ohio, New Jersey and Massachusetts have also taken steps this year to reduce employee costs for local governments. From curbing contract bargaining to imposing higher employee contributions for health care and pensions, legislatures and governors have sought to ease fiscal burdens for municipalities.

Debt service is generally less than 10 percent of a state or local government’s budget, and in many cases it’s much less, Richard Raphael, an analyst at Fitch Ratings in New York, said in a report last November.

Whitney’s “60 Minutes” comments fanned mounting concerns that focused on municipal financial stress.

Six months earlier, Warren Buffett said Berkshire Hathaway Inc., where he is chairman and chief executive officer, had been trimming its investment in municipal debt. He told a hearing of the U.S. Financial Crisis Inquiry Commission in New York that a “terrible problem” was brewing in the market.

By November, Republicans including Newt Gingrich, the former speaker of the U.S. House of Representatives, were urging Congress to consider letting states go bankrupt as a way to break union contracts and restructure pensions.

States Excluded

A Depression-era law that lets municipalities reorganize their finances under Chapter 9 of the U.S. bankruptcy code excluded states.

Investors began an exodus from municipal-bond mutual funds last year, pulling out $30 billion. The weekly net withdrawals that began in November didn’t end until last month, according to Lipper US Fund Flows in Denver.

In January, billionaire investor George Soros weighed in, telling CNBC that municipal finances would be the “drama” for the year while former President Bill Clinton said at the World Economic Forum in Davos, Switzerland, that local governments needed “some reform” in the way they handle their finances. Jamie Dimon, JPMorgan Chase & Co.’s CEO, said some cities would use bankruptcy courts to rewrite union contracts and pensions.

Market Roiled

Then in a February report, Roubini Global Economics LLC, started by New York University economist Nouriel Roubini, predicted $100 billion of municipal defaults during the next five years, which would require an annual pace that is more than twice the record reached in 2008. Roubini in 2005 predicted a bubble in U.S. housing prices and correctly forecast the global credit crisis.

Municipal bond prices plummeted, pushing yields higher. A Municipal Market Advisors index of yields on top-rated 20-year municipal debt climbed from about 3.6 percent at the end of August, the lowest since the index began, to almost 4.8 percent by Jan. 14, the highest in 22 months. The index yield stood at 4.2 percent this week.

Prediction Disputed

By then, investors including Bill Gross, who runs the world’s biggest bond at Pacific Investment Management Co. in Newport Beach, California, were publicly disputing Whitney’s prediction. In April, McDonnell Investment’s Ciccarone said municipal-cash figures showed Whitney was on the wrong track.

The market has rebounded as the wave of defaults she predicted failed to materialize. The benchmark iShares S&P National AMT-Free Bond Fund, with a $2.17 billion market valuation, has had a total return of 7.2 percent since Whitney’s “60 Minutes” appearance, according to data compiled by Bloomberg.

“She’s been a tremendous marketing tool for us because she’s been out there challenging the industry,” said Anson Clough, managing director of fixed income at Appleton Partners Inc. in Boston, which oversees $4.4 billion of assets.

“That’s why we invest in municipal bonds -- municipalities have the ability to get through this,” he said. “They have that taxing power.”

--Bloomberg News--


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