Tax revenues (income, sales and property) and user fees from essential services keep coming and remain diverse. In the current downturn, muni credits are generally weaker, but default is still a distant risk, in our view. If one sector of the economy is hard hit in a recession, other sectors may be less so, allowing the core of the muni issuer’s revenue stream to stay relatively steady. This creates a steady revenue stream for GO municipal issuers that’s very different from that of a corporate issuer dependent on discretionary spending. Taxes, for example, are applied across a diverse base of earnings and property values. Municipalities’ power to tax or charge for public services translates into a reliable revenue engine that yields dependable, quality cash flows. Privately owned utilities, on the other hand, need permission from an independent oversight regulatory commission.Ģ) Cash Flow: A Steady and Reliable Revenue Engine Given all the protections in the bond issue, publicly owned utilities can set their own rates. Typical issues include safety provisions like requirements to set rates in excess of budgeted expenses, restrictions on issuing more debt, and requirements to fund reserves to cover unexpected events.Ĭompare a municipal-owned electric utility with one that’s privately owned. Most tax-exempt revenue bonds are at the top of an enterprise’s capital structure. Those fees are pledged to service debt, and in tough times, issuers can raise user fees to make debt payments. Revenue bonds are backed by fees from public-service enterprises like utilities, toll roads and airports. In the private sector, most companies can’t claim that type of customer backing or pricing flexibility. Many states and municipalities need voters’ approval even to issue GOs, and they can’t declare bankruptcy-even in a crisis. Whether a GO funds schools, transportation infrastructure or other essentials, the issuer typically has the power to raise taxes to make bond payments. GO muni bonds are backstopped by the “full faith and credit” of the issuing government. The two principal types of municipal debt, general obligation (GO) and revenue, have traits that better equip them to deliver steady cash flows. Here’s a closer look at five reasons why muni defaults are rare:ġ) Security: Muni Issuers Have the Power to Raise Taxes and Fees Why is municipal-bond quality so high-and defaults so infrequent? We can find the answer by drilling into the tenets of fundamental analysis: understanding the quality and predictability of a bond’s cash flows and the attributes of bond issuers that make investors more confident that they can deliver. Comparing muni default rates over that period with those of investment-grade corporate bonds, which have defaulted at a rate of 2.2%, reinforces the reliability of municipal bonds. Since 1970, for example, the 10-year cumulative default rate for investment-grade municipal bonds has been 0.1% (Display). It’s an impressive track record, and it explains why defaults by municipal issuers Puerto Rico and Detroit have made front-page news when they happen-they’re actually quite rare. Default rates by municipal bond issuers have been remarkably low over the years.
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