Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

Recovery Rates

Aside from the probability of default, potential high yield investors may also want to know how much of their money they may eventually recover from a default/bankruptcy situation. So far, we have been able to find only one study specifically addressing recovery rates on municipal bonds, a report published by Fitch in January 2007, titled “Default Risk and Recovery Rates on U.S. Municipal Bonds.”7 As a general comment, Fitch states that “because of the dearth of municipal bond defaults, recovery data are far from robust. However, available data demonstrate that most municipal sectors have superior recovery prospects to corporate bonds, which have an average recovery rate of about 40 percent” (our emphasis). In terms of recovery prospect, the Fitch study further divides the tax-exempt universe into six broad classes, as follows:

Class 1: State general obligation debt, state sales tax.

Class 2: Local general obligation, tax-backed debt, insured health care, public college tuition/revenue, housing (insured and single-family), transit, and water/sewer/gas.

Class 3: Lease/appropriation-backed, airports, marine ports, public power distribution.

Class 4: CCRCs, nursing homes, private colleges/secondary schools, state/local multifamily, tax-increment/tax allocation bonds, museums/stadiums, parking, established bridges/toll roads, public power generation, and waste disposal.

Class 5: Military housing, startup bridges/toll roads.

Class 6: Hospitals, private prisons, ...