The Safety of Muni Bonds and Their Investment Potential

Muni bonds have a low default rate, with only 0.2% of municipal bonds defaulting between 1970 and 2018.

Municipal bonds are considered a safe investment because they are backed by the credit of the issuing municipality, which is typically strong and stable.

The credit ratings of municipal bonds are also a key factor in determining their safety, with high-rated bonds offering a lower risk of default.

Investors can also take comfort in the fact that municipal bonds are exempt from federal income tax, making them an attractive option for those looking to minimize their tax liability.

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General governments and municipal utilities tend to be highly rated, with 62% of all general government bonds being rated investment grade (Aa3 or higher).

But, it's worth noting that less than 6% of GO bonds are in the Baa category, which is one notch above junk. That number is over 18% for revenue bonds.

Looking at credit ratings, GO bonds rarely go bust, making up less than a quarter of all municipal bond defaults from 1970 to 2020.

However, when GO bonds do default, they can be particularly devastating, with over 75% of the dollar volume or value of the defaults attributed to them.

Investors can check the record of a municipality and its credit rating to make an informed decision, looking for bonds rated BBB or better by Standard & Poor or Fitch, or rated Baa or better by Moody.

Most bonds, however, are non-callable, which means they can't be redeemed by the issuer unless it's a special circumstance.

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Default risk is a concern for investors, and GO bonds are not as safe as they seem. Less than 6% of GO bonds are in the Baa category, which is one notch above junk, while over 18% of revenue bonds have this rating.

GO bonds rarely default, but when they do, the dollar amount of the defaults is much greater. This is because the taxing authority of the state or city has helped keep defaults low, but when they do occur, they can be catastrophic.

Here's a breakdown of the credit ratings for GO bonds and revenue bonds:

Recent defaults, such as Detroit's and Puerto Rico's, have thrown a lot of risk onto the world of GO bonds. These defaults have shown that even GO bonds can be treated as "unsecured" creditors, which can lead to significant haircuts for bondholders.

GO bonds rarely default, which is a major advantage for investors. In fact, Moody's investment grade rating scale is Aaa, Aa, A, and Baa, and GO bonds tend to fall within the higher-rated categories.

According to Fitch's investment-grade rating scale, GO bonds are often rated AAA, AA, A, or BBB. This suggests a strong creditworthiness and low risk of default.

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The credit ratings for revenue bonds, on the other hand, vary more widely and are often lower than those for GO bonds. For example, 62% of general governments, which include GOs, are Aa3 rated or higher, whereas only 41% of competitive enterprises, which include revenue bonds, are Aa3 or above.

Here's a rough breakdown of the credit ratings for GO bonds and revenue bonds:

As you can see, GO bonds tend to have higher credit ratings and a lower risk of default compared to revenue bonds. This is one of the reasons why GO bonds are often considered a safer investment option.

General obligation (GO) bonds are often considered the safer option in the municipal bond market, but the data suggests otherwise. GO bonds are backed by the full faith and credit of the municipal government, which has historically been considered a secure pledge.

However, Detroit's bankruptcy in 2013 changed the market's view on risk. The city initially tried to treat its GO bondholders as "unsecured" creditors, which would have gone against the market's longstanding belief of the security pledge of GOs.

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GO bonds have a lower default rate than revenue bonds, but when they do default, the dollar amount is much greater. Less than a quarter of all municipal bond defaults from 1970 to 2020 were GO bonds, but they were responsible for over 75% of the dollar volume of defaults.

GO bonds are often rated investment grade, with 62% of all general government bonds, which includes GO bonds, rated Aa3 or higher. However, this has led investors into a false sense of security, as when GO bonds do default, they can have significant consequences.

The defaults of Detroit and Puerto Rico are examples of this. Both entities stopped paying on their GO bonds but still made payments on their water and sewer bonds. GO bondholders took significant haircuts in both scenarios.

Here's a comparison of the default rates and credit ratings of GO bonds and revenue bonds:

This data suggests that GO bonds are not as safe as they seem, and investors should be cautious when investing in them.

Municipal bonds can be a great way to invest in your community, but it's essential to do your research. The most popular category among retail investors is General Obligation (GO) bonds, which are issued by state or local governments and have a repayment driven by their taxing authorities.

These bonds are relatively safe, as the ability for the government to raise taxes to cover them adds a level of safety and reduced risk. In fact, GO bonds have long been the top choice for many municipal bond investors.

However, not all municipal bonds are the same. Revenue-backed bonds, which are issued to finance specific projects, have a different repayment structure and may carry more risk.

To invest in municipal bonds, it's crucial to check the municipality's record of paying on time. You can find this information on the Municipal Securities Rulemaking Board's Electronic Municipal Market Access portal.

A good credit rating is also essential. Look for bonds rated BBB or better by Standard & Poor or Fitch, or rated Baa or better by Moody. Even better, look for those that earn the highest rating from Moody (Aaa), Standard & Poor (AAA) or Fitch (AAA).

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Here's a quick rundown of what to check:

By doing your research and being aware of the potential risks and benefits, you can make informed investment decisions and potentially help build new schools or finance a city's operating budget.

General obligation bonds, or GO bonds, have a reputation for being safe investments. According to Moody's, GO bonds are often backed by charter schools, higher education, private colleges & universities, hospitals & health service providers, hotel, housing, not-for-profit, and private K-12.

However, data suggests that GO bonds may not be as safe as we think. Less than 6% of GO bonds are in the Baa category, which is one notch above junk. This is compared to over 18% of revenue bonds, which are often considered riskier.

GO bonds rarely default, but when they do, the consequences can be severe. According to Thornburg, GO bonds were responsible for over 75% of the dollar volume or value of defaults, despite comprising less than a quarter of all defaults. This has led some to question the safety of GO bonds.

The market has been repricing risk in recent years, and the spread between GO bonds and revenue bond yields has narrowed. Historically, revenue bonds used to yield much more than GO bonds, but this is no longer the case.

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If you're looking to maximize returns on your municipal bonds, focus on higher rated issuers, those rated AA-/Aa3 or above.

Investors can consider combining general obligation bonds with other essential service revenue bonds to build a well-diversified portfolio.

General obligation bonds can serve as the core of a muni portfolio when combined with other essential service revenue bonds.

Competitive Enterprises, as defined by Moody’s, can be a good starting point for diversification, including charter schools, higher education, private colleges & universities, hospitals & health service providers, hotel, housing, not-for-profit, and private K-12.

Municipal bonds have historically been a favorite among high-net-worth investors, and it's easy to see why. They're free from federal taxes, and in some cases, state and local taxes as well, making them a lucrative option for investors of all income bands.

But not all municipal bonds are created equal. They fall into two broad categories: revenue-backed bonds and GO bonds. GO bonds are the more popular choice among retail investors, making up 28% of the $3.8 trillion municipal bonds market.

Here's a breakdown of the two categories:

The safety and reduced risk of GO bonds come from the ability of the state or local government to raise taxes to cover their bonds. This added layer of security makes GO bonds the top choice for many municipal bond investors.