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What Kind of Risk is Present in Municipal Bonds?

A lot of municipal credit risks were exposed when the financial crisis hit in 2008, with municipal insurance companies failing, merging or getting downgraded. This brought scrutiny to the municipal market as some investors began to question the safety of muni bonds. It’s important, however, to remember that not all municipal bonds carry the same amount of risk. The market, after all, offers a variety of types and legal pledges.

There are two main types of municipal bonds: general obligation and revenue bonds. General obligation bonds carry the full faith and credit of the issuing municipality and are typically paid through property taxes. Revenue bonds, which cover sectors such as water, sewer and education, are funded by the revenues of that specific project and typically do not carry the full-faith backing of the municipality. 

With revenue bonds, certain projects are more essential than others. Projects like water and sewer systems or public university improvements are considered essential in purpose. No matter the state of the economy or project itself, a municipality cannot afford to default on these types of programs because they are vital services for a community. However, projects such as housing and health care systems tend to have limited purposes and resources and are generally not viewed as being essential services. Therefore, municipalities are much more likely not to intervene when these projects become insolvent. This is shown in the default table below. As you can see, housing and health care projects make up the vast majority of municipal defaults over the past 40-plus years. Defaults in general obligation and essential service revenue bonds remain rare occurrences, as evidenced by the default statistics for education, cities/counties/states and water/sewer projects.

 

Municipal Default by Sector, 1970–2012

SECTOR

# of Defaults

%

SECTOR

# of Defaults

%

Housing

29

39.7%

Water & Sewer

2

2.7%

Hospitals/Health Svc. Providers

22

30.1%

Counties

2

2.7%

Infrastructure

4

5.5%

Special Districts

0

0.0%

Education

3

4.1%

State Governments

0

0.0%

Cities

3

4.1%

Pool Financings

0

0.0%

Utilities

2

2.7%

Other

1

1.4%

Source: Moody’s

Bottom line: We don’t believe in taking risks with fixed income. We focus on high-credit-quality general obligation and essential service revenue bonds, such as water/sewer, university revenue and highway/transportation. These sectors have historically shown low-default rates. On the other hand, we strictly avoid unstable sectors such as health care, housing and industrial development.

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Copyright © 2014, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.



 

How Does the Stock Market Work?

Everyone talks about "the market" and few understand how it works. The following video, produced by Dimensional Fund Advisors, is intended to change that.

video platformvideo managementvideo solutionsvideo player

Eugene Fama Awarded Nobel Prize in Economic Sciences

We are thrilled to share the news that Eugene Fama, widely recognized as the “father of modern finance,” has been named a co-recipient of the 2013 Nobel Prize in Economic Sciences.

Professor Fama serves on Dimensional Fund Advisors’ (one of our strategic partners) board of directors and on its Investment Policy Committee, where he advises the firm on many of its strategies. He is also Chairman of the Center for Research in Security Prices at the University of Chicago Booth School of Business.

His work began in the 1960’s with the development of what’s known now as the Efficient Market Hypothesis, and since then, he’s worked extensively on understanding how financial markets work. 

It is rewarding to see such a high level of recognition given to Dr. Fama. His contributions have served as the bedrock of our investment philosophy since the day we opened our doors in 1999 and have shaped how we help our clients make investing less taxing and achieve their most important goals.

All of us at Lauterbach Financial Advisors congratulate Professor Fama on this great honor. 

Learn more: 

Wall Street Journal: A Nobel for the Random Walk of Stock Prices

Business Insider: Nobel Prize Winner Eugene Fama Explains Why You Have No Chance Of Beating the Market

Watch:

Eugene F. Fama: Economist. In this interview recorded in 2008 and conducted by Professor Richard Roll, Eugene F. Fama discusses his life, research, and contributions to the field of finance.

It's Important to Be an Educated Investor

The following are some key investing principles that investors should know.

 

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Disclaimer: By clicking on any of the links above, you acknowledge that the links provided are solely for your convenience, and do not necessarily imply any affiliations, sponsorships or endorsements. We make no representations whatsoever regarding such third party websites. You should review the privacy policies of other websites carefully before providing any information to such sites. We are not responsible for the content or availability of third-party websites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through such third-party websites. These selected readings are being provided for informational purposes only and do not constitute investment advice and do not necessarily represent the opinions of Lauterbach Financial Advisors. Nothing in these materials should be interpreted as implying the performance of any client accounts or securities recommendations. Lauterbach Financial Advisors does not provide any guarantee, express or implied, that the information presented is accurate or timely, and does not contain inadvertent technical or factual inaccuracies. The past performance of securities is no guarantee of their future result.