Analyzing Credit of Municipal Bonds
Two general types of municipal bonds (or “munis” as they are commonly called):
- Tax-backed or general obligation bonds.
- Revenue bonds.
These bond types require their own distinct approaches when performing credit analysis.
Tax backed bonds: factors to consider
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The debt burden of the community. This is commonly examined in terms of debt per capita, debt as a percent of real estate values, and/or debt as a percent of community personal income.
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The community’s budget history (i.e. does the community have a history of budget deficits?).
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Calculate the community’s tax base and its access to other sources of revenue.
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Evaluate the community’s socioeconomic landscape.
Revenue bonds: factors to consider
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Four C’s Analysis: With respect to cash flow analysis, revenue bonds are more similar to corporate bonds, than tax backed bonds are, so a four C’s approach is relevant when assessing the credit quality of a revenue bond issue.
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Understand the revenue source backing the bond.
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Understand the flow of funds for the bond. Bondholders commonly receive a net revenue pledge, which means that debt service payments come after operational expenses of the municipality’s project are covered.
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Understand the charge rates, which is the manner in which the customers of the bond financed project are charged for using the service provided by the project.
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Understand the legal priority of revenue claims.
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Understand the conditions under which additional bonds can be issued.