Municipal Bond Basics
GO Credit Analysis: Items considered when rating [i.e., AAA] a GO: 9. Unfunded Liabilities [unfunded pension liabilities] ● Stable or low levels are positive ● Unstable or high levels are negative 10. Operating Deficits [shortfalls in budgets for operations] ● Low levels of deficits are considered positive ● High levels of deficits are considered negative 11. Attitude of municipality toward debt: ● If municipality tries to avoid debt, generally considered positive ● If municipality issues debt often & for frivolous purposes, generally considered negative
12. Population Demographic [including average age, average education level, average income level, etc.]. Would be the make-up of the municipality's tax base. ● An educated, young & growing population considered positive because tax revenues can be expected to increase. ● An elderly & declining population considered negative because even with stable debt, tax revenues can be expected to decrease. 13. Budget Practices: ● Fiscally conservative municipality considered positive ● Fiscally irresponsible municipality considered negative.
GO Credit Analysis - GOs are frequently rated by analysts to determine creditworthiness of the issuer. ● Rating Services: Moodys, Standards & Poors, Fitch ● Items considered when rating [i.e. AAA] a GO: 1. Outstanding Debit * Stable or low levels of debt are positive * Unstable or high levels are negative
2. Per-Capita Debt [debt per person within the municipality] * Low levels are positive / High levels are negative 3. Debt / Value Ratio - [Debt owed by the municipality in relation to the overall value of the municipality & the municipality assets.] * Low ratio is positive / High ratio is negative 4. Debt to Property Value Ratio [Debit of municipality in relation to the property values of taxable real estate.
GO Credit Analysis: Items considered when rating [i.e. AAA] a GO: 5. Character of the Economy ● Stable or booming economy is positive ● Unstable or faltering is negative 6. Tax Collection Record ● Good tax collection record, signified by collections in full & on time, is positive ● Poor Tax collection record, signified by late, partial, or non-existent collections, is considered negative
7. Property Valuation Trends ● Increased property values - positive ● Decreasing property values - negative 8. Tax Rates ● Stable or decreasing tax rates - positive [strong economy & muni gov't considered fiscally responsible] ● Unstable or increasing tax rates - negative [signify unstable & weak economy & muni gov't overspends & not fiscally responsible]
Assessed Value & Mills: Tax Assessment Exercise: A piece of property has a Mkt value of $200,000,000 is assessed at 50% of Mkt value & taxed at the rate of 5 mills. What would the property tax revenue to the municipality be?
Answer: $500,000 $200,000,000 x 50% = $100,000,000 $100,000,000 x 5 mills or [0.005] = $500,000
A Municipal note is BEST described as: ● A long-term security issued to finance capital construction ● An instrument secured by the US Treasury or federal agency issues ● An unsecured instrument issued to obtain funds for short-term loans ● A short-term issue used for interim financing
Answer: A short-term issue used for interim financing A municipal note is typically issued to finance projects on an interim or temporary basis until the proceeds of long-term bonds are received by the issuer.
An analyst is evaluating a general obligation municipal bond. All of the following situations would be considered to have a negative affect on the bond EXCEPT? ● the issuance of long-term debt to satisfy current debt service on outstanding debt ● A stable level of outstanding debt when property values are appreciating ●a diminishing tax base ●unfunded pension liabilities are increasing
Answer: A stable level of outstanding debt when property values are appreciating Explanation: All of the choices listed would be negative except for the stable level of outstanding debt while property values appreciated. In this situation, the incoming taxes from property values are increasing while the debt level is remaining stable. If anything, this would increase the credit rating of the municipality.
In analyzing a GO bond, which of the following factors would be most important? ● Existing competitive facilities ● Protective covenants ● Budgetary practices ● A feasibility study
Answer: Budgetary practices Explanation: A G.O. bond is a general obligation bond. It is repaid from general tax revenues and expenditures for a specific time period. Budgetary practices would be relevant in analyzing a G.O. bond. The other three factors would be relevant in analyzing a revenue bond.
The ratio of taxes collected to taxes levied would be important in analyzing which of the following municipal bonds? ● Industrial development bonds ● Public housing bonds ● General obligation bonds ● Pollution control bonds
Answer: General Obligations bonds Explanation: A general obligation bond is repaid from tax revenue and borrowings. The other bonds are repaid from the revenue generated by a specific facility built by the revenue bonds.
Which of the following would NOT be a reason for a municipality to issue revenue bonds versus general obligation bonds? ● only certain members of the community will use the project ● Statutory debit limitations are usually enforced on revenue bonds. ● Current legislation at the state level requires that self-sufficiency of projects of this nature. ● User fees are expected to support the project once completed.
Answer: Statutory debit limitations are usually enforced on revenue bonds. Explanation: Revenue bonds are NOT subject to statutory debt limits. All other choices are correct with regard to Revenue bonds
General obligations [GOs] municipal bonds are backed by: ● Taxes & other general revenues ● the unlimited power of the issuer ● Special assessments ● The non-binding pledge to pay by a state legislature
Answer: Taxes & other general revenues Explanation: General obligation (G.O.) municipal bonds are backed by the "full faith and credit" of the issuer i.e. the taxing power of the issuer. The taxing power is not unlimited. It is subject to constitutional or statutory limitations. G.O.s can be paid off from tax revenue, bonds revenue or other general revenue. Special assessments are used to pay off revenue bonds. A non-binding pledge from a state to pay off a bond is called a moral obligation bond.
In analyzing a GO municipal bond, all of the following would be considered negative factors, EXCEPT: ● an increase in the tax rate ● an increase in the value of taxable property ● an increase in the delinquent rate ● an increase in the expenditures in excess of reve
Answer: an increase in the tax rate Explanation: A general obligation (G.O.) municipal bond is backed by the "full faith and credit" of the issuer which means it is repaid from general taxes and borrowings. An increase in the delinquent rate, taxes, and in expenditures in excess of revenues would be negative factors. An increase in the value of taxable property would be a positive factor.
BANs
Bond Anticipation Notes
Direct debt + overlapping debt =
Net overall debt
Municipal Tax Income: GO Bonds issued by the LOCAL LEVEL GOV'T: The Pymt of interest & principals issued by a counties, cities, towns, school districts, library districts and other local gov't entities is usually secured by
Real Estate Taxes / Property Taxes. ● Real Estate / Property Tax Assessments. * has 2 values: Mkt vs. Assessed * Always taxed at the Assessed Value. Never the Mkt Value * Taxed in Mills [a fractional part of a penny]. 1 mill = $0.001.
RANs
Revenue Anticipation Notes
Municipal Tax Income: GO Bonds issued by the STATE LEVEL GOV'T: The Pymt of interest & principals issued by a state is are usually secured by
Sales Tax and/or Income Tax.
Overlapping debt never occurs at that
State Level.
TRANs
Tax & Revenue Anticipation Notes
TANs
Tax Anticipation Notes
Legislative Risk - If federal tax exempt status was removed, it would have
a devastating effect for municipal bonds.
Contiguous Overlapping Debt is debt shared by
different municipalities sharing the same borders.
Note: Muni bonds are subject to
interest rate risk & inflation or purchasing power risk.
Overlapping Debt is the debit for which
more than 1 municipal entity is responsible. Overlapping debt only occurs at the LOCAL GOV'T Level & is supported by taxes.
General Risk: General risk factors - when comparing a GO to a Revenue Bond, the GO would generally be considered to be
safer because the GOs are backed by taxes whereas the Revenue Bond is dependent on user charges.
Important Point: Basic 4-function calculation will not accept such large numbers,
so do these problems by hand.
Municipal bonds are bonds issued by
state & local gov't entities such as cities, counties, school districts & the state.
Municipal Tax Income: GO Bonds are [secured by
taxes collected] by the municipality & are [not limited] to the revenues derived from any 1 specific project. Thea re issued to finance [non-revenue[ producing projects.
Direct Debt is debt for which
the municipal entity is solely responsible.
Feasibility Study is a study done by a municipality prior to the issuance of a revenue bond
to determine estimated costs & revenues of the project. The study would consider construction expenses, service charges & estimated number of users. [is wanted, needed, maintenance & cost of use].
Revenue Bonds: ● Primarily Backed by User Charges [Toll roads & bridges, Airport fees, etc.] ● Also can be backed by Lease Pymts, License Fees [fishing license] & Special Taxes [excise tax [luxury taxes] - cigarettes, liquor, etc]
● Backed by Protective Covenants - Protective covenants only apply to revenue bonds. * Re[ven]ue - Co[ven]ants ● Flow of Funds Provision - determines the priority of income revenues ● No Voter Approval Required. A Feasibility Study is required to determine self-sustainability ● No Statutory Debt Limits ● Generally usually issued as Callable
General Obligations are ● Backed by Taxes [Income, Real Estate, Sales] * Backed by the taxing power of the municipality ● Issued for facilities that benefit the public * Schools, Libraries, City Hall
● Because they are backed by taxes paid by the public * Voter Approval is Required before issuance * Statutory Debit Limits Apply ● No Flow of Funds Provision - no incoming revenues ● No Protective Covenants ● Generally Not issued as Callable
General Obligation Bonds:
● Bonds that are a general obligation of the issuing municipality ● Also known as "Full Faith & Credit Bonds" ● Most States Require Voter Approval for Issuance ● Amount general obligation bonds issued are subject to statutory or constitutional debt limit
Municipalities generally have 2 types of debt:
● Direct Debt ● Overlapping Debt
Other Facts about GO analysis: ● The "debt to value" ratio is significant when evaluating general obligation bonds [GOs]. ● The "debt service coverage" is significant when evaluating revenue bonds. ● Budgetary practices are important when analyzing a GO bond.
● Factors used to evaluate REVENUE BONDS include feasibility studies, covenants & competing facilities ● Comparisons between 2 municipalities must be closely evaluated because the basis of assessing the value of property & assets is different from municipality to municipality [which can create large differences in the numbers, even though the municipalities may be very similar].
Ad-Valorem / Limited Tax Bonds are
● GO Bonds where the municipalities puts a statutory limit on the tax rate that may be levied. ● Prior to issuance, these bonds require voter approval like any other GO bonds.
3 Major Categories of Municipal Bonds
● General Obligation Bonds [GOs] ● Revenue Bonds ● Municipal Notes
Benefits of investing in Municipal Bonds include
● Interest is exempt from federal income tax ● Interest may be exempt from state & local income taxes ● Principal & interest pymts are fixed ● There's a wide range of issuers & maturities ● Geographic diversification
Municipal Notes:
● Note = Short Term maturities ● Notes are securities that have short term maturities. ● Are used for Interim or Temporary Financing ● When thinking about Municipal Notes think of: * TANs, RANs, TRANs & BANs
Ad-Valorem / Limited Tax Bonds: GO Bonds Local Level - secured by Property Taxes ● An ad-valorem tax is a tax "according to value for GO bonds backed by assessed valuations on property.
● State gov'ts receive little or no revenue from Real Estate [ad-valorem] tax. ● Real Estate assessments & how they are computed may vary from district to district. ● These taxes do not fund revenue bonds.
Examples of overlapping debt for a city or town are:
● a library district ● a school district & ● a park district But NOT an airport authority [Revenue Bond]
