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.