Handbook of Finance: Valuation, Financial Modeling, and Quantitative Tools

Chapter 27. The Credit Analysis of Municipal Bonds

SYLVAN G. FELDSTEIN, PhD

Director, Investment Department, Guardian Life Insurance Company of America

FRANK FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

Abstract: At one time, investing in municipal bonds had been considered second in safety only to that of U.S. government obligations. Today, however, many investors have ongoing concerns about the credit risk of municipal bonds. This is true regardless if the bonds carry a high investment-grade credit rating as assigned by rating agencies. While the purpose of common stock analysis is for the analyst to predict the future earnings and profitability of a corporation, the role of municipal credit analysis is less dramatic but nevertheless very important. Furthermore, several approaches to municipal bond credit analysis exist. There are no universally accepted theories of municipal credit analysis as there are in the fields of common stock and corporate bond analysis.

Keywords: general obligation bonds, debt burden, budgetary soundness, tax burden, revenue bonds, general public purpose financings, trust indenture, legal opinion, flow-of-funds structure, net revenue, gross revenues, debt service coverage, additional-bonds tests

The credit analysis of many types of municipal bonds and notes, particularly general obligations of state and local governments where political processes are heavily involved, is more of an art than a science. Nonetheless, municipal ...