Junk-bond boom sets up big distress for billions of debt

Businesses that flooded the municipal-bond market with debt sold through government agencies are helping drag the industry into its biggest wave of financial distress in nearly a decade.

The risky corporate ventures aren’t what one typically associates with the $3.9 trillion haven backed largely by states and cities, which are at little risk of defaulting even during economic calamities like the one that’s gripped the nation for the past five months.

But companies eligible for federal subsidies issued tens of billions of dollars of tax-exempt debt in recent years, seizing on a surge of cash into the junk-bond market as investors chased bigger returns.

Now, with the economy rocked by the biggest collapse since World War II, a small but growing number are struggling to repay what they borrowed, threatening to roil that corner of the muni market and add to the corporate bankruptcies piling up across America. Among those in trouble, there’s a biofuel factory in Maine; the Mandarin Oriental hotel near the banks of the Potomac River in Washington, D.C.; and Graceland, the Elvis Presley shrine hit by fewer tourists due to COVID-19.

This year, more than 50 municipal-bond issues worth $5 billion have defaulted — the most since 2011, according to Municipal Market Analytics, an independent research firm. Nearly two dozen more have drawn on reserve funds since the start of the year to cover debt payments when revenue fell short, a potential sign of more stress to come, according to data compiled by Bloomberg.

“They’re really just starting,” said Lisa Washburn, chief credit officer at Municipal Market Analytics, which tracks municipal-bond defaults. “It was just more than the deals could handle.”

The increased distress belies the relative calm in even the riskiest segment of the municipal market, where investors have continued to pile in despite the downturn set off by COVID19. While the first waves of shutdowns set off a steep selloff in March, high-yield municipal bonds have since fully rebounded, tracking the rally across markets as the Federal Reserve eased monetary policy aggressively.

That has caused yields in the state and local debt market to slide to the lowest since the early 1950s, maintaining the low borrowing costs that fueled a record wave of junk-bond deals — many of which are now facing their first major test.

Sales of high-yield debt by state and local government agencies — for projects like nursing homes, charter schools and real estate development — surged by 31% in 2019 to nearly $17 billion, the most since at least 2012, according to Bank of America. More than $10 billion was sold only to big institutional buyers able to handle the risk, according to data compiled by Bloomberg.

The flood of easy money bankrolling speculative projects already meant that some distress was inevitable, but the pandemic is presenting an added challenge, said Bill Black, a senior portfolio manager at City National Rochdale.

“There’s certainly more to come,” he said, though he added that he expects it to be contained enough that the performance of the broader high-yield market won’t be imperiled.

Ms. Washburn, the analyst with Municipal Market Analytics, said she’s expecting the stress to continue to pile up.

“Going into 2021, you’ll probably see even more pressure on more safe sector credits,” she said.