Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

Definitions of Default

One of the most thoughtful discussions to date on municipal default analysis comes from a surprising source: the National Association of Insurance Commissioners (NAIC), charged with determining a risk rating scheme for the insurance industry’s investment holdings, including municipals. In a recent white paper entitled “Issues in Municipal Default Analysis,” the NAIC observes:

If we assign all municipal finance activity sectors to one of three groups based on common default characteristics, we find that only those municipal finance sectors that are backed by tax or tax like authority default at a lower rate than corporate or structured securities. A second group of municipal finance sectors, which provides for corporate or structured like repayment mechanisms but is associated with essential government activity, default at a rate only slightly lower than corporate securities. The third group, which provides for corporate or structured like repayment mechanisms but is associated more with traditionally private than government activity, defaults at rates almost identical to that of corporate securities.1

It certainly makes sense that the further the project strays from an essential municipal function, the higher its likelihood of default. This is due to the fact that public entities will go out of their way to protect one of their essential services from default, and they usually have access to taxing and fee-raising capability to support those services. At ...