Municipal securities markets

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See also Build America bond, municipal bankruptcy, municipal pensions, municipal securities, muni swaps and Municipal Securities Rulemaking Board.


2010 market size and ownership

"...The size of the municipal market reflects its significance to the economy. In 2009, there were approximately $2.8 trillion of municipal securities outstanding. Much of that amount is held directly or indirectly by retail investors. Individuals directly hold about 35 percent of the outstanding municipal securities, and another 34 percent is held by money market funds, mutual funds, and closed end funds on behalf of primarily retail investors.

But, the municipal market is not solely the province of buy-and-hold investors. Trading in this market has been substantial. In 2009, almost $3.8 trillion of long and short term municipal securities were traded in over 10 million transactions..."

2nd quarter, 2010 muni issuance

Source: *Municipal Bond Credit Report Second Quarter 2010, SIFMA, September, 2010

SIFMA released its comprehensive Municipal Bond Credit Report for the second quarter. Using Thomson Reuters data, the new report cited that in the second quarter of 2010 municipal issuance, including both taxable and tax-exempt, totaled $100.2 billion, a drop of 3.6% from the first quarter and a 9.7% decrease from the same period last year.

Taxable issuance modestly gained market share in the second quarter, claiming 32.8% of all municipal issuance compared with 32.5% in the first quarter and 20.8% from second quarter 2009. The report stated that while Build America Bonds (BABs) accounted for most of the taxable issuance (76.7%) in the second quarter, some $2.4 billion in non-BAB taxable bonds were issued following the enactment of the Hiring Incentives to restore Employment Act (HIRE Act).

For the complete municipal report, including data and charts on state issuance by type, issuance by region, use of proceeds, issuance by ratings and quality trends, as well as, analysis of BABs, VRDO usage and a update on municipal auction rate securities

2009 muni trade data from the MSRB

The Municipal Securities Rulemaking Board (MSRB) today released its 2009 Fact Book, an annual sourcebook that analyzes trading data and statistics for the $2.8 trillion municipal bond market. The Fact Book includes analysis on nearly every trade reported to the MSRB by municipal securities dealers in the last five years and provides key municipal market statistics unavailable elsewhere.

This year's Fact Book includes for the first time interest rate resets information and trading statistics for auction rate securities and variable rate demand obligations. The MSRB began collecting this data in 2009. Also new to this year's Fact Book are lists of the most actively traded municipal securities and trading volume for newly issued securities.

The MSRB, which regulates municipal securities dealers, collects and disseminates official data about the municipal securities market as part of its mission to protect and educate investors. The MSRB makes municipal trade data available free of charge on its EMMA website. Daily and historical summaries of trade data based on security type, size, sector, maturity, source of repayment and coupon type are housed in EMMA's Market Statistics section. An electronic version of the MSRB 2009 Fact Book also is available free of charge on EMMA and at

Muni rating downgrades accelerate

Ratings for 279 state and local- government tax-backed bonds were reduced in 2009, up from 81 the previous year, as the recession cut tax collections and strained budgets, Moody’s Investors Service said.

Including bonds backed by revenue, such as those of hospitals and housing authorities, seven ratings were raised for every 10 that were reduced in the municipal market, the lowest ratio in at least 20 years. Ratings fell for 300 revenue debt issuers, up from 133 the prior year, Moody’s said.

The trend toward weaker credit quality was spread through the municipal market, and most ratings cuts were attributable to the worst economic recession since the 1930s, the rating company said.

“We expect negative trends to continue for the next 12-18 months” even though some economists report the recession is lifting, the report said.

Ratings reductions for three states -- California, Illinois and Arizona -- boosted the value of downgraded tax-backed bonds to $199.8 billion, the most in at least two decades. Including revenue-backed issues, $256.3 billion of debt was reduced, or about 9 percent of the $2.8 trillion municipal market.

The results aren’t part of Moody’s plan to overhaul its 27,000 municipal ratings to make them more comparable with corporate and sovereign bonds. That effort was postponed in 2008, and “Moody’s expects to provide guidance on the status” this quarter, said John Cline, a spokesman for the New York-based company.

Moody’s said ratings improved in 2009 for 320 tax-backed state and local-government issuers with $27.1 billion of debt, led by school districts in Texas. Revenue bond ratings rose for 64 issuers with $13.1 billion of bonds.

California’s $72 billion of general obligation and lease- backed bonds, the most of any state, were reduced to Baa1 from A1 during the year. Illinois, with $24 billion of debt, was cut to A2 from A1 with a negative outlook, and Arizona to A1 with a negative outlook from Aa3, affecting $1.8 billion.

Bond Buyer "Advance Refunding Calculator"

The Bond Buyer and Andrew Kalotay Associates are pleased to announce a new feature for our online users - a refunding calculator designed to help issuers make decisions related to advance refunding deals by factoring in the value of the call option embedded in their existing deals. Based on Kalotay's proprietary valuation algorithms and supported by data from Mergent Technologies, Municipal Market Advisors, and BondDesk Group, the calculator allows issuers or their professional advisors to retrieve real bonds, and evaluate the attractiveness of various refunding scenarios.

BofA Merrill leads 2010 muni underwriting

Bank of America Merrill Lynch in 2010 reclaimed its title as the top underwriter of municipal debt, thanks mainly to its dominance in the competitive market.

The bank underwrote $59.9 billion of muni bonds in 2010, a 7.5% increase from 2009, based on a Thomson Reuters methodology that apportions credit for underwritings based on how much of a syndicated deal was placed through each underwriter.

These deals gave B of A Merrill a 13.9% share of the market, placing the firm in the top spot among municipal underwriters after losing that claim to Citi in 2009.

After winning the top underwriter title in 2009, Citi came in second place in 2010 with $58.9 billion of deals for a 13.7% share of the municipal market. Citi’s underwriting volume rose less than 1%.

Citi had no comment. B of A did not respond to a request for comment.

With such similar shares of the market, the difference between Bank of America and Citi is B of A’s preeminence in the competitive market, where banks bid for deals, as opposed to the negotiated market, where selected underwriters try to place deals with investors.

B of A Merrill far and away takes on the most municipal bonds in the competitive market. It underwrote $11.4 billion of munis in the competitive market in 2010, according to Thomson, good for a 15.6% share of the competitive market and more than $2 billion more than the second-most-active bank, Citi.

In the negotiated market, where 83% of municipal debt was underwritten, Citi was the most active. It underwrote $49.6 billion of bonds in the negotiated market in 2010, for a 13.9% share. B of A was second with a 13.6% share.

JPMorgan once again placed in third overall for 2010, with $46.9 billion of underwritten deals and a 10.9% market share. Morgan Stanley came in fourth with $36.8 billion s and an 8.6% share.

Last year was a wild one for public finance desks as municipalities set a record by borrowing $431.9 billion. Not only did underwriters face more volume than ever, they also had to find buyers for an unprecedented volume of taxable bonds.

More than 35% of municipal borrowing last year came through taxable bonds, mostly because of the taxable bond classes created through the American Recovery and Reinvestment Act in February 2009.

The fourth quarter was especially crazy, as municipalities tried to push through about $133 billion of bonds, in part to bring the taxable bonds to market before the ARRA programs expired at the end of last year.

The rush of supply pushed yields up 68 basis points in the fourth quarter, based on the Municipal Market Advisors 30-year triple-A scale.

Citigroup leads 2009 muni underwriting

Citi experienced great difficulties throughout the financial crisis but in the municipal world it was business as usual. The firm took top honors for municipal underwriting in each year of the tumultuous decade, capturing 14.4% of the market overall, according to data from Thomson Reuters.

Click here to see 2009 Rankings

Annual rankings show that Citi ran the books on 399 issues totaling $58.1 billion in 2009, giving the New York-based bank a 14.3% share of the market. The number of deals Citi closed fell 22% compared to 2008 but overall issuance sizes were larger and that allowed Citi to increase volume by 4.3%.

A close second in the overall rankings was Bank of America Merrill Lynch, which captured 13.6% of the market on 513 issues totaling $55.4 billion.

Impressive as that is, it doesn’t match 2008 when — acting as separate units before announcing the merger in September of that year — B of A and Merrill controlled 15.7% of the market share on 695 issues totaling $60.6 billion. Together that outweighs Citi’s share in 2008, giving B of A Merrill the top spot in Thomson Reuters’ chart, but as the merger didn’t officially take effect until Jan. 1, 2009, Citi never actually got knocked from its high ground.

In any case, last year Citi was a top-10 player in each municipal sector, but it was three particular areas that helped the firm retain its title.

Citi was senior manager on 97 general purpose deals worth a total of $22.7 billion in the year — 115% more than in 2008 — accounting for 17.7% of the market. In transportation, the firm managed 50 deals worth $10.0 billion, accounting for 20.5% of the market. And in health care, it absorbed 20.2% of the issuance pie, leading 83 deals amounting to $9.0 billion.

JPMorgan remained in third place as it ran the books on 387 issues for a total of $46.9 billion. The firm improved its market share to 11.5% in 2009 from 9.8% in 2008.

The 2009 rankings show that the biggest firms continue to dominate the market, in largely the same order.

Outside the merger of Merrill and Bank of America, it can be seen that each of the top nine firms in 2009 was in the top 10 in 2008. The only top-10 player of 2008 not to make it into the ranks last year was UBS Securities LLC, which mostly exited the public finance business in 2008, and as a result sank from the seventh spot in 2008 to 15th last year.

Indeed, for all the talk of large firms scaling back their operations and giving room for smaller firms to climb the ranks, the top eight firms accounted for 71.1% of all underwriting in the year, in line with the decade’s average of 71.9%.

However, there were some notable climbers. The most obvious was Ramirez & Co., which jumped to 20th place as it managed $2.7 billion of issuances last year from the 60th spot in 2008 when it managed $307 million.

The trend of the dominant few extends to the Build America Bonds program, which hit the market in late March as part of the Obama administration’s stimulus package.

In Thomson Reuters’ new category tracking stimulus-related issuances — 95% of which are BABs, while 4% are qualified school construction bonds and 1% are recovery zone economic development zone bonds, qualified zone academy bonds, or clean renewable energy bonds — Goldman, Sachs & Co. took command. The firm controlled 14.7% of the stimulus market on 36 issues totaling $9.9 billion. More than a quarter of all Goldman underwriting was for BABs, placing it fifth in the overall senior manager ranks.

Looking at the 2009 municipal market by sector shows two dramatic movements. Issuance of general purpose bonds advanced a whopping 59.7% in the year as underwriters managed 3,548 deals worth $128.3 billion. In contrast, housing-related issuance fell 40.4% from $17.4 billion in 2008 to $10.4 billion last year.

Meanwhile, in terms of selecting an underwriter, competitive deals rose nearly 9% in 2009, but the clear choice for issuers remains negotiated underwriting, which increased by 4.3% and accounted for 85.7% of all transactions.

The number one underwriter of negotiated deals was Citi with 15.6% of the market share. In competitive deals, by contrast, Citi placed only fifth as rival B of A Merrill grabbed 17.2% of the deals.

The top spot for small-issue underwriters — $10 million or less — went to Milwaukee-based Robert W. Baird & Co., which climbed from seventh in 2008. On 436 separate deals totaling $1.773 billion, Baird seized 7.8% of the market, bumping Morgan Keegan & Co. to second place with 6.2% of the market.

RBC Capital Markets, which was the top underwriter for small deals for 16 consecutive years through 2006, fell one spot to third in 2009 with a 5.7% market share.

In the rankings of financial advisers, Public Financial Management Inc. ranked first for each year of the decade. In 2009 it advised on 829 deals worth a total of $51.5 billion and controlled 16.4% of the market.

Notable movements in the financial adviser category include NW Financial Group LLC, which climbed from 113th in 2008 to 13th last year. The New Jersey-based firm advised on 17 issues totaling $3.8 billion in 2009, compared with just $264 million in 2008. In the other direction, Morgan Keegan fell from the top 10 to number 20 — the firm advised on 83 deals totaling $2.47 billion, about half of the prior year’s total.

Among issuers, the largest by far in 2009 was California. The Golden State sold $23.2 billion of munis last year, almost three times more than in the previous year. With 24 separate issues, the state took up 5.7% of the total market, far more than the number-two participant, the Dormitory Authority of the State of New York, which captured 1.8% of the market with $7.5 billion of deals.

California’s largest sale was so big it eclipsed the cumulative issue amounts from every other issuer in the country except one. On April 22, the state came to market with a $6.86 billion taxable deal — the fourth-largest single issuance in history. The transaction was priced by a syndicate led by Goldman, JPMorgan, Barclays Capital, and Morgan Stanley.

In the decade as a whole, California issued $90.4 billion in 105 separate deals — almost double the $48.8 billion issued by New York City, which ranked as the second-largest issuer in the decade.

Muni underwriting fees at 8 year high

Source: Muni underwriting fees at 8 year high Bond Buyer, August 21, 2009

"The fees issuers pay to bankers to underwrite municipal bonds are higher then they’ve been for eight years, as the financial crisis heightened risk and decimated competition in the industry.

State and local governments this year are paying underwriters an average of $6.46 for every $1,000 borrowed, according to Thomson Reuters.

That payment, known as the underwriting spread, is up sharply from last year’s $4.83 average spread.

The last time issuers paid higher fees was 2001.

Underwriters and other market participants cite a number of factors for the fatter spreads, some on the supply side of the equation and some on the demand side."

...Created under the stimulus act, BABs (Build America bonds) allow municipalities to sell taxable munis and in lieu of the traditional tax exemption receive a subsidy from the federal government equal to 35% of the interest costs.

Issuers have sold $26.75 billion of BABs since the launch of the program in April, according to Bloomberg LP.

Bankers have charged more to underwrite BABs — an average of $8.04 per $1,000 face, compared with $6.27 for other munis, according to Thomson.

The crisis also knocked out a pillar of demand in municipals.

Earlier this decade, a group of hedge funds was buying munis to arbitrage what they perceived as irrationally high yields on long-term munis.

The arbitrage strategy required a complex hedging system using derivatives. The hedges assumed a stable relationship between tax-exempt yields and certain taxable yields, like the London Interbank Offered Rate or Treasury yields.

The flight to safety last year disrupted these relationships and many of the funds were forced to liquidate their positions after the hedges failed. As a result, a major contingent of buyers for munis vanished.

“They were really driving the demand side of the equation,” Yosca said of the municipal arbitrage funds. “That buy-side component seems to be a thing of the past now, so you’ve got to find alternative places to put the bonds.”

Falling tax collections

State tax collections during the first quarter of 2009 showed the sharpest decline on record, dropping 11.7 percent overall, according to a new Rockefeller Institute report.

The decline in personal income tax was particularly sharp, with an unprecedented decline of 17.5 percent, as the weakened economy continued to hammer state budgets.

Forty-five of the 50 states experienced revenue drop-offs. Early figures for the second quarter reveal continued, broad worsening of fiscal conditions for states. Local tax revenue, meanwhile, remains relatively steady.

California municipal issues

"... Included in the bills he [Schwarzenegger] signed is a measure sought by investment banks to expand so-called “negotiated,” or no-bid, municipal bond sales and a bill requiring more disclosure by placement agents seeking to win pension fund business from state and local governments.

The no-bid bond bill, which supporters said was needed after the Wall Street credit crisis made competitive auctions more difficult, allows California’s 58 counties and 480 cities to sell general-obligation debt through negotiated offerings, in which the municipality decides in advance which banks will market it.

In competitive offerings, banks submit their lowest interest-cost bids on an advertised day. Current law allows negotiated sales by cities and counties for lease-backed and revenue bonds and by school districts.

The increasing use of no-bid deals in public finance has ignited debate over whether it saddles taxpayers with higher costs, since banks may set higher interest rates on bonds when they know they have a deal in advance. Banks have an incentive to raise interest rates on such securities, because it makes debt easier to sell, limiting the risk that underwriters will be left holding unsold bonds.

Bid sales saved issuers 17 to 48 basis points, “on average and all else equal,” according to a study published in the Winter 2008 issue of the Municipal Finance Journal. A basis point is 0.01 percentage point.

The no-bid measure passed by unanimous votes in both chambers of the Legislature. It was supported by the League of California Cities and California State Association of Counties. The California Association of County Treasurers and Tax Collectors opposed it.

Source: California Lawmakers Approve More No-Bid Bond Deals Bloomberg, August 28, 2009

"California lawmakers passed a bill sought by investment banks that would expand no-bid bond sales, which supporters say are needed after the Wall Street credit crisis made competitive auctions more difficult.

The bill allows California’s 58 counties and 480 cities to sell general obligation debt through negotiated offerings, in which the municipality decides in advance which banks will market it. In competitive offerings, banks submit their lowest interest-cost bid on an advertised day. Current law allows negotiated sales by cities and counties for lease-backed and revenue bonds and by school districts.

“With the way the economy and the bond markets were, it was difficult to get people to participate in the competitive bid process,” said Pedro Salcido, a legislative consultant to Assemblyman Ed Hernandez, a Los Angeles-area Democrat who carried the bill.

The municipal bond market has been upended by the two-year financial crisis, which caused the collapse of the largest bond insurance companies and the Wall Street arbitrage funds that once snapped up the local securities they guaranteed. Five of the largest 12 municipal underwriters have been bought or exited the market since 2007.

The measure passed by unanimous votes in both chambers of the Legislature. It now goes to Governor Arnold Schwarzenegger, a Republican. It was supported by the League of California Cities and California State Association of Counties. The California Association of County Treasurers and Tax Collectors opposed it.

Higher Costs

Schwarzenegger spokesman Mike Naple said the governor hasn’t yet taken a position on the legislation.

The increasing use of no-bid deals in public finance has ignited debate over whether it saddles taxpayers with higher costs, since banks may set higher interest rates on bonds when they know they have the deal in advance. Banks have an incentive to raise the interest rates on such securities, because it makes them easier to sell, limiting the risk that underwriters will be left holding unsold bonds.

More than a dozen academic studies show competitive bidding saves taxpayers money -- 17 to 48 basis points “on average and all else equal,” according to one study published in the Winter 2008 issue of the Municipal Finance Journal. A basis point is 0.01 percentage point. The savings mean $1.7 million to $4.8 million less in interest payments on the life of a 10-year bond.

“This is just another very clever scheme,” Lee Buffington, treasurer of San Mateo County, said in a telephone interview. “It’s the good ol’ taxpayers that are getting screwed here.”

Divergent Bids

Proponents of negotiated deals, including the underwriters and some of the financial advisers on whom municipalities rely, say these transactions allow more time to find investors and get the lowest cost.

James Cervantes, a banker with Stone & Youngberg in San Francisco and the vice chairman of the group that backed the legislation, said competitive sales have produced more widely divergent bids than in the past, which illustrates banks’ lack of confidence in their ability to resell bonds soon after buying them in an auction sale

“It tells you there’s less confidence in where the market is,” he said. “That’s a function of the disruption that hit our market, just like the broader capital markets, since September.”

Most Since 1977

That’s why AAA rated issuers have a better chance of selling bonds at competitive sales than do lower-rated issuers, Cervantes said. “Our thinking was it makes sense to acknowledge that and let local jurisdictions decide what made sense for them,” he said.

Local governments and not-for-profits have negotiated most sales since 1977. Last year, such issues accounted for 86 percent of the $391.3 billion of new municipal bonds, according to Thomson Reuters data. Nationally, $35.8 billion, or 15 percent, of the municipal bonds sold this year were sold by competitive auctions among underwriters, according to data compiled by Bloomberg.

Underwriting spreads for the first half of 2009, according to Thomson Reuters, show negotiated rose to $6.33 per $1,000 face value, the highest since full year 2001. Competitive rose to $6.91, the highest since 1996. All bonds rose to $6.38, the highest since 2001.

The California bill repeals an existing provision of a state law requiring annual interest and principal payments on debt issued by a municipality to be structured so that the maximum annual debt service payment does not exceed the minimum annual amount by more than 10 percent.

“This is just a rip off of taxpayers,” Buffington said."

Federal regulatory response

"The staff of the Securities and Exchange Commission has expressed its belief that California’s recently-issued IOUs are “securities” under federal securities law. As such, holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities."

The MSRB notes in particular its Rule G-30, which requires dealers to effect purchases and sales of municipal securities at fair and reasonable prices based on the dealer’s best judgment of their fair market value, and also requires dealers to charge fair and reasonable commissions in connection with brokered transactions. Dealers must deal fairly with customers and must not take advantage of a customer’s need for cash by offering to purchase registered warrants at deeply discounted prices that are below what could reasonably be viewed as their fair market value.

More details on a dealer’s fair pricing obligations are included in a January 26, 2004 MSRB notice.

Published quotations regarding offers to buy or sell registered warrants must be bona fide and must be based on the dealer’s best judgment of fair market value under MSRB Rule G-13, and advertisements regarding registered warrants are subject to MSRB Rule G-21.

MSRB Rule G-17 requires that, at or prior to the time of entering into a transaction, dealers must disclose to their customers material information about the transaction that is known to the dealer or is otherwise available from established industry sources. More details on this disclosure obligation are included in a March 20, 2002 MSRB notice.

Dealers buying, selling, or trading the registered warrants would be expected to know and to disclose to customers material information about the registered warrants available from, among other sources, the websites of the California State Controller and the California State Treasurer.

In particular, dealers selling registered warrants to customers must ensure that purchasing customers are aware of the terms on which the registered warrants are expected to become payable (including information about the contingent nature of the stated maturity date, the potential for early redemption, and any contingencies concerning tax exemption of interest on the warrants).

In addition to making the necessary disclosures to customers, dealers are required by MSRB Rule G-19 to consider such information when determining whether recommended purchases or sales of the registered warrants are suitable for their customers.

Dealers also would be expected to provide their customers with documentation of the transaction that may be necessary for customers to receive payment on the registered warrants upon presentment to the California State Treasurer’s Office. Further, dealers must provide confirmations of their transactions to customers in compliance with MSRB Rule G-15.

The MSRB understands that the registered warrants may not have CUSIP numbers, and, if so, transactions in the warrants need not be reported to the MSRB’s Real-Time Transaction Reporting System under MSRB Rule G-14.

Even so, dealers must maintain all appropriate records of their transactions with customers under MSRB Rule G-8, and such records are subject to examination by the appropriate regulatory agencies. Employees of dealers who engage in sales and trading of the registered warrants must have passed an examination qualifying them to engage in such activities -- either the Series 7 exam or a more specialized exam such as the Series 52."

Size of municipal securities market

"A glimpse at the Bond Buyer's summary of Thomson Reuters data from the first half of the year shows how much the market has changed (highlights only):

Comparing January to June, 2008 and 2009 (Percent Change)

New Issuance

  • Total new issuance -16.2%
  • First quarter -0.1%
  • Second quarter -25.6%
  • Tax-exempt -15.8%
  • Taxable +56.8%
  • New money +1.6%
  • Refunding -36.9%
  • Combined -32.6%

Method of Sale

Negotiated -15.8% Competitive -16.6% Private placements -60.5%


Revenue -28.3% General obligation +12.0%


Fixed-rate +15.3% Variable rate (short put) -79.6% Variable rate (long/no put) -9.8%

Bank-qualified +90.6%

With bond insurance -62.1% With letters of credit -73.8% With standby purchase agreements -94.5%

General statistics

Outstanding par value: $1.8 trillion

  • Market cap of Wilshire 5000 – about $10 trillion
  • Number of securities outstanding – 1.3 million
  • Total NYSE, NASDAQ, AMEX securities - about 8,500
  • Number of muni issuers – 51,000
  • Number of corporate issuers – about 7,300

--Volume of new issues

Long-term issuance

  • 2002 - $359 billion (14,400 offerings)
  • 2003 - $384 billion (15,039 offerings)
  • 2004 - $360 billion (13,601 offerings)
  • 2005 - $408 billion (13,939 offerings)

Short-term issuance

  • 2002 - $72.4 billion (3,545 offerings)
  • 2003 - $69.8 billion (3,425 offerings)
  • 2004 - $56.6 billion (3,276 offerings)
  • 2005 - $50.5 billion (3,270 offerings)

Daily trading activity

  • Issues traded (CUSIPs) - 11,000
  • Less than 1% of outstanding
  • Par traded - about $10 billion
  • $81 billion traded in major US equity markets
  • Number of trades - about 30,000
  • About 4 billion shares traded on major equity markets

Risks of muni bonds

Source: MRSB Notice 2009-38 (JUNE 30, 2009)

As some state and local jurisdictions struggle with the fall-out from current economic conditions, investors should be aware that:

  • Defaults, while quite rare, do occur.
  • Information about financial problems that affect the bond’s issuer has not always been readily available to investors.
  • The current market value of a municipal bond may be hard to determine because many municipal bonds trade infrequently.
  • A bond’s market value may change for reasons having nothing to do with the financial condition of the issuer, such as a change in interest rates.
  • In cases where an issuer has purchased bond insurance or some other protection feature, the higher overall credit rating of a bond may be more reflective of that protection than of the financial condition of the issuer.

Investors considering an investment in municipal bonds should bear in mind that no two municipal bonds are created equal—and they should carefully evaluate each investment, being sure to obtain up-to-date information about both the bond and its issuer.

Default rates of muni bonds

The primary concern of all bond investors is whether they will ultimately get their money back. This is especially the case with municipal bond investors: Municipal bond investors willingly accept lower yields compared to other fixed income investments primarily due to the safety record of municipal bonds.

When an issuer fails to live up to the payment obligations of a particular bond issue, the bond is considered to be in default. If an issuer misses an interest payment or fails to pay back the principal on the scheduled date, this does not necessarily mean that the investor will not get their money back. With municipal bond defaults, investors many times get most of their money back. The amount of money that the investor receives from a bond investment that has defaulted is known as the recovery rate.

The 3 largest ratings agencies, Standard & Poor’s, Moody’s, and Fitch Ratings, have each produced a case study examining default risk and recovery rates of municipal bonds. We will summarize the findings from each of these studies below. Investors may also click on the following links to directly access the three studies.

Fitch Ratings:

Standard & Poor’s:



Each of the 3 ratings agencies assigns ratings to various municipal bond issues as a part of their business; the ratings classify credit risk just as an individual’s credit score is used to assess credit risk. Generally, a municipal issuer such as a school district or a state pays the rating agency to have an upcoming bond issue rated. Just as with individuals, the better the credit rating, the cheaper it is for the issuer to borrow money. The ratings agency analyzes the various risk factors associated with a particular bond issue and the issuer. Based on the rating agencies assessment of the risk factor, the issuer is assigned a credit rating (Aaa, AAA, Baa, etc…).

In its 2003 study, Fitch Ratings concluded the following:

Based on two studies released in 1999 and 2003, Fitch reviewed all municipal bond defaults between 1987-2002. Based on the results of its findings, Fitch Ratings came to conclusion that the different types of municipal bonds fit into three categories of default risk….Class 1, Class 2, and Class 3.

Class 1, the safest category, is comprised of most local and state general obligation bonds. Class 1 also includes general obligation and revenue bonds issued by established authorities with no competition or natural monopolies in essential public services. Altogether, Class 1 includes the following types of bond issues:

  • State general obligation bonds
  • Local general obligation bonds
  • Local school districts
  • Appropriation-backed and tax-backed debt of local and state governments
  • Public power distribution
  • Water and Sewer Authorities
  • Public higher education
  • Single family housing

In this category of issuers, the cumulative default rate between 1987-2002 was .24%; the comparative default rate during this same period for AAA-rated global corporate debt was .43%.

Class 2 from a default perspective is comprised of public service enterprises providing essential services, but where the enterprise is subject to competition or fluctuation in demand. The bonds issued in Class 2 are generally revenue bonds providing services such as:

  • Public power generation (as opposed to distribution which is in category 1)
  • hospitals
  • waste disposal
  • private colleges and universities
  • military and state multifamily housing
  • museums and stadiums
  • airports and seaports
  • toll roads with established traffic patterns

In Class 2, the five-to-fifteen year cumulative default rate between 1987-2002 was .70%; the comparative default rate during this period for AA-rated corporate bonds was .73%. The types of bonds in Class 2 have a similar default rate to AA-rated corporate bonds according to the Fitch Ratings study.

In Class 3, the issuers are comprised of entities that compete with private enterprises and have highly unpredictable or volatile revenue streams. These types of issuers include:

  • Nursing homes and continuing care retirement facilities
  • Industrial development bonds
  • Local Multifamily housing
  • Toll roads without established traffic patterns
  • Tobacco bonds
  • Tribal gaming

In Class 3, the five-to-fifteen year default rates of 3.65% are comparable to 3.97% for ‘BBB+’ rated corporate bonds.

An interesting assessment made by the Fitch study is that Fitch expects that even if the ratings are similar, a single A-rated airport bond will have a higher expected default rate than a state or school district also rated single A. This should lead an investor to place an emphasis on the type of bond issue being considered in addition to the bond’s rating. Municipal bonds rated similarly can have vastly different characteristics. According to this Fitch study, the type of issuer and issue is as important as the credit rating when evaluating the likelihood of future default.

Recovery Rates:

When a municipal bond defaults, the investor generally will still receive some money back from their investment; this is known as the recovery rate. In some cases and with certain types of issuers, the recovery rate can be as high as 100% or 100 cents on the dollar. In some cases, a temporary default on interest payments can be cured with some late payments from the issuer and the issuer can resume servicing the debt once again according to schedule.

Comparing different categories of municipal bonds to corporate bonds maybe accurate in terms default rates, but the recovery rates are another matter according to Fitch. Corporate bonds have an average recovery rate of about 40% or 40 cents on the dollar.

Fitch in this study creates 6 classes of recovery rates. The first 3 classes are assumed to have recovery rates of 100% of the principal.

Class 1:

  • State GO debt
  • State sales tax backed debt

In the event of default in this class, Fitch assumes a recovery rate of 100% of the principal amount with an assumed loss of 1-years interest.

Class 2:

  • Local general obligations
  • Local tax-backed debt
  • Transit authorities
  • Water, sewer, gas
  • Public colleges and universities, GO and tuition-revenue backed
  • Single family housing

For Class 2, Fitch assumes a recovery rate of 100% of the principal with 2-years of missed interest payments.

Class 3:

  • local and state leases, certificates of participation, and appropriation-backed
  • Airports and seaports
  • Power distribution

For Class 3, Fitch’s model assumes a recovery rate of 100% with 5-years of missed interest payments.

Class 4:

  • Waste disposal
  • Nursing homes and retirement facilities
  • Private colleges and universities
  • Established Bridges and roads
  • Museums and stadiums
  • Public power generating facilities
  • State and local multifamily housing

For class 4, Fitch’s model assumes a recovery rate of 90%.

Class 5

  • military housing
  • start-up and new bridges and toll roads

For Class 5, Fitch’s model assumes a recovery rate of 70%.

Class 6:

  • private prison
  • stadiums
  • student housing
  • private university bonds backed by auxiliary revenues
  • hospitals
  • tribal gaming

For Class 6, Fitch assumes 40% recovery rates.

Fitch doesn’t explicitly address where many other types of bonds such as industrial development bonds, tobacco securitizations, etc..


The way an investor would use this information is by being aware of the default risk and recovery rates of various categories of municipal bonds. Rather than simply relying on a rating or a recommendation, information such as this historical analysis from Fitch Ratings should provide you an additional set of data points in helping you understand the risks of investing in municipal bonds.

Investors should be aware that this is simply one analysis done by Fitch Ratings in 2003 and the information should be considered as an educated opinion based on a historical analysis of municipal bond defaults.


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