Texas town is downgraded to junk in wake of default

BY SourceMedia | MUNICIPAL | 08/20/24 02:28 PM EDT By Karen Pierog

A default on debt issued by a Texas town struggling with water scarcity led to multi-notch downgrades into junk by S&P Global Ratings and heightened concern about the impact of climate change on public finance.

Clyde, a city of less than 4,000 in central Texas, failed to make debt service payments due Aug. 1 on combination tax and surplus revenue certificates of obligation sold in 2013 and 2022 and submitted claims to bond insurers that guaranteed payment on the debt.

In disclosure notices posted on the Municipal Securities Rulemaking Board's EMMA website last week, the city said the move "reflects financial difficulties of the issuer, including without limitation financial difficulties resulting from increased costs related to operations and maintenance of the issuer's waterworks and sewer system, as well as decreased 'surplus revenues' of the system, which are pledge to payment of the obligations."

The notices also pointed to Clyde's water problems, culminating in an Aug, 1 stage 3 drought response that declared a water emergency with the goal of achieving a 30% reduction in daily water demand.

Clyde's 2022 issue, which totaled $14.35 million with a final maturity in 2052, is insured by Assured Guaranty (AGO). In 2013, the city sold $3.815 million of taxable Series B debt wrapped by Build America Mutual with a final maturity in 2029.

S&P on Friday cut the underlying ratings on the two issues to D from A-minus to reflect the default, downgraded the ratings on Clyde's general obligation and other outstanding debt to B from A-minus, and placed the B ratings on a watch list for potential further downgrades.

"The CreditWatch placement reflects a one-in-three chance we could lower the rating within the next 30 days, during which time we expect to receive more information on the city's financial operations and performance of the city's waterworks and sewer system fund and general fund," S&P analyst Misty Newland said in a statement.

Clyde Mayor Rodger Brown did not immediately respond to a request for comment.

The default is highlighting climate change and how bond insurance can mitigate that risk for investors.

"Clyde's miss should be a catalyst for a more serious and permanent discussion on the many ways climate change can impact the financial health of issuers in the municipal market even if the financial cost to holders is minimal via the insurance policy," Municipal Market Analytics said in its latest weekly outlook report, which also pointed to the city's increased debt load as a contributing factor for the default.

The latest U.S. Drought Monitor showed mostly abnormally dry conditions in Callahan County, where Clyde is located.

BAM spokesman Michael Stanton said insurance protected investors with timely payment of interest and principal, as designed.

"Although this is a small exposure, our team is in contact with city officials and their professional advisors and will continue to represent bondholders' interests in those discussions," he added.

Robert Tucker, Assured's senior managing director of investor relations and communications, said "the type of situation Clyde, Texas encountered ? unexpected conditions leading to the non-payment of debt service ? is exactly what our bond insurance is designed for."

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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