Municipal Bond - Risk

Risk

The risk ("security") of a municipal bond is a measure of how likely the issuer is to make all payments, on time and in full, as promised in the agreement between the issuer and bond holder (the "bond documents"). Different types of bonds are secured by various types of repayment sources, based on the promises made in the bond documents:

  • General obligation bonds promise to repay based on the full faith and credit of the issuer; these bonds are typically considered the most secure type of municipal bond, and therefore carry the lowest interest rate.
  • Revenue bonds promise repayment from a specified stream of future income, such as income generated by a water utility from payments by customers.
  • Assessment bonds promise repayment based on property tax assessments of properties located within the issuer's boundaries.

In addition, there are several other types of municipal bonds with different promises of security.

The probability of repayment as promised is often determined by an independent reviewer, or "rating agency". The three main rating agencies for municipal bonds in the United States are Standard & Poor's, Moody's, and Fitch. These agencies can be hired by the issuer to assign a bond rating, which is valuable information to potential bond holders that helps sell bonds on the primary market.

Municipal bonds have traditionally had very low rates of default as they are backed either by revenue from public utilities (revenue bonds), or state and local government power to tax (general obligation bonds). However, sharp drops in property valuations resulting from the 2009 mortgage crisis have led to strained state and local finances, potentially leading to municipal defaults. For example, Harrisburg, PA, when faced with falling revenues, skipped several bond payments on a municipal waste to energy incinerator and did not budget more than $68m for obligations related to this public utility. The prospect of Chapter 9 municipal bankruptcy was raised by the Controller of Harrisburg, although it was opposed by Harrisburg's mayor.

Read more about this topic:  Municipal Bond

Famous quotes containing the word risk:

    Combining paid employment with marriage and motherhood creates safeguards for emotional well-being. Nothing is certain in life, but generally the chances of happiness are greater if one has multiple areas of interest and involvement. To juggle is to diminish the risk of depression, anxiety, and unhappiness.
    Faye J. Crosby (20th century)

    Maybe we were the blind mechanics of disaster, but you don’t pin the guilt on the scientists that easily. You might as well pin it on M motherhood.... Every man who ever worked on this thing told you what would happen. The scientists signed petition after petition, but nobody listened. There was a choice. It was build the bombs and use them, or risk that the United States and the Soviet Union and the rest of us would find some way to go on living.
    John Paxton (1911–1985)

    The Englishman’s strong point is his vigorous insularity; that of the American his power of adaptation. Each of these attitudes has its perils. The Englishman stands firmly on his feet, but he who merely does this never advances. The American’s disposition is to step forward even at the risk of a fall.
    Thomas Wentworth Higginson (1823–1911)