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
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.
The community’s budget history (i.e. does the community have a history of budget deficits?).
Calculate the community’s tax base and its access to other sources of revenue.
Evaluate the community’s socioeconomic landscape.
Revenue bonds: factors to consider
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.
Understand the revenue source backing the bond.
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.
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.
Understand the legal priority of revenue claims.
Understand the conditions under which additional bonds can be issued.
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- CFA Level 2: Fixed Income Part 1 – Introduction
- Principles of Credit Analysis
- High Yield Corporate Debt (aka Junk bonds)
- Analyzing Credit of Asset Backed Securities
- Analyzing Credit of Municipal Bonds
- Sovereign Debt
- Three Shapes of the Yield Curve
- Parallel and Non-parallel Shifts in Yield Curve
- Factors Driving Treasury Investment Returns and Bond Price Risk
- Yield Curve Construction with Treasuries
- LIBOR Swap Rate Curve
- Theories of the Term Structure of Interest Rates
- Key Rate Duration
- How to Calculate Interest Rate Volatility?
- Benchmark Yield Spreads
- Valuing an Option Embedded Bond using Binomial Interest Rate Tree
- How to Price Convertible Bonds?