1. Municipal Bonds BA 561 – Supply Chain Management April 30, 2012
Chip Ullstad

2. Overview What is a municipal bond? Who sells municipal bonds & why?
Who buys municipal bonds & why?
Bond ratings, risks and regulation
Summary & Questions

3. What is a municipal bond?
Fixed debt instruments
Tax secured bonds
Revenue secured bonds
Tax secured, two types, general obligation bonds secured by a community’s full faith and credit (a phrase used primarily in conjunction with General Obligation bonds to pledge use of all taxing powers and resources, if necessary, to pay the bond holders. Moral obligation, state offers non-binding promise to pay.
Revenue bonds, secured by dedicated revenue stream such as water, sewer or other user fees
Terms range from years, average 15. Daily trading volume about $16 B/day.
Terms and volume

4. Who sells municipal bonds?
State and local governments
School districts
Service districts
Public utilities
The first municipal bond in the US was sold by New York City in 1812 to fund construction of the Erie Canal
Self-funding infrastructure

5. Why sell a municipal bond?
Fund capital improvements
Tax leveraged financing
Align revenue and debt streams
Stagger principal repayment
Short term financing

6. How are municipal bonds sold?
Voter approval
Legal opinion
Audit report
Competitively bid
Structure (serial bonds)

7. What is a serial bond?

8. Bond funded facilities

9. Reliance on municipal bonds
Over the past 65 years municipal bond debt has increased from $20B following world war II to 3.7 T in 2010, almost 200 fold.
1945
1980
2010

10. Who buys municipal bonds?
MUNICIPAL BOND INVESTORS, 09/2011
About 50% of municipal bonds are held by individual investors or households, mutual funds hold about 25% and institutional investors hold the remaining 50%.

11. Why buy a municipal bond?
Tax exempt earnings
l Federal (almost all)
l State (depends)
l Local (depends)
Almost all municipal bonds provide a federal tax shelter. There are some municipal bonds that the federal government doesn’t deem eligible for tax exempt earnings, because of limited public benefit. These are termed taxable bonds and are used to fund Investor-led housing, local sports facilities, and borrowing to replenish a municipality’s underfunded pension plan
Advantages vary with AGI

12. Tax Equivalent Rates (Federal)
Tax shelter advantage of municipal bonds varies from 1.5% to 2% based on federal income tax bracket. This spread is greater when state and local income taxes are considered.

13. States with income tax
Income tax benefits from municipal bonds can be further leveraged in states and cities with income tax. 43 of 50 states and Washington DC have state income taxes that provide tax shelters to municipal bonds sold within their state.

14. Example Frances, AGI = $250,000

15. Example Charlie, AGI = $20,000

16. Bond Rating Agencies Bond rating agencies Ratings protect bond buyers
l Moody’s (major)
l Standard & Poors (major)
l Fitch (minor)
Ratings protect bond buyers

17. Bond ratings and risks Bond rating criteria Regulation l Economy
l Financial health
l Demographics
Bonds are regulated by the Municipal Secrities Rule Making Board, an advisory commission to the SEC,
Regulation

18. Risk comparison
Highly rated municipal bonds (AAA & AA) have not defaulted. Investment grade municipal bonds (BBB and greater) about 20X safer than similarly rated corporate bonds.

19. Summary Muni’s fund capital improvements
Two general types of bonds & security
Individual & institutional investors
Can shelter earned & investment income
Municipal bonds are fixed debt instruments that fund capital improvements for state, local and quasi-governmental organizations.
Two types of bonds – tax secured general obligation bonds and revenue secured bonds
Like all investments, carry risk

20. Questions

21. References
Bond rating criteria,
Municipal bond regulation,
Municipal bond debt history,
Definition of municipal bonds,
Data for municipal bond holder graph,
Serial bond table (munis vs. corporate,
Map, state income tax rates,
Municipal bond rating criteria,