August 14th, 2011
Econintersect: Municipal bonds (munis) are issued by states, cities, or other local government agencies have long been regarded as a relatively safe investment with household investors owning about two-thirds of the $2.9 trillion market.
Many headlines over the past two years point expressed concerns over default. This study concludes:
Municipal markets have been buffeted by concerns about issuer quality, investor protection, reliance on short-term funding sources, and exposure to unstable liquidity guarantors.
Various market participants have responded to address these fears in a number of ways, whether by clarifying existing arrangements, modifying them, or developing new ways to mitigate risks. Although the long-term fiscal condition of municipal issuers remains a concern, they have largely managed to retain their ability to access capital markets, reflecting a recovery of investor confidence in assessing and pricing the risks associated with these investments.
Two graphics in the study are incorporated in this post. The first is a graphic on the growing volumes of muni bonds being issued, as well as the associated yields.
The second graphic relates to states which allow municipal bankruptcy. Much investor concern has been expressed in the potential of loss due to cities declaring bankruptcy.
The study states:
Municipal bankruptcies do not generally result in any losses for bond investors. In each of the approximately 300 Chapter 9 filings over the past 40 years, bond investors were repaid in full, if sometimes late. In some cases, the payments were made not by the issuers but by fi nancial institutions that had provided letters of credit or bond insurance. An important reason why municipal bondholders are typically repaid even when a local government defaults is that debt service costs are usually small, averaging just over 4% of revenue flows. In addition, many municipal bonds are backed by dedicated revenue sources, such as toll roads or sewer systems.
source: Chicago Fed