Are municipal bonds a secure investment

January 28, 2011
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Huge budget deficits in states like California and Illinois prompted at least one leading analyst to raise concerns about the safety of investing in municipal bonds, which aren’t immune to trouble but have long been considered among the safest of debt markets.

In a recent story in U.S. News and World Report, Meredith Whitney, a high-profile banking analyst, predicted that 50 to 100 municipal bonds worth hundreds of billions of dollars would default this year under the growing weight of budget deficits. Whitney said that would lead to a sell-off in the municipal bond market that would stifle any chance for an economic recovery and force local governments to cut back on services and lay off more employees.

Of course, other analysts disagreed and said that scenario is unlikely. They pointed to the fact that there have been only four defaults since mid-2009 in what are thought to be the three safest sectors of the municipal bond market. Those are general obligation bonds, tax-backed bonds and essential services bonds; the city of Grand Rapids has issued bonds in all three sectors.

“Typically, the city of Grand Rapids issues general obligation bonds, and most of these are issued by the Grand Rapids Building Authority. In some cases, the city’s general obligation debt service is supported by a combination of income- and-property-tax allocations,” wrote Jana Wallace, debt and financing officer for the city, in an e-mail to the Business Journal.

A general obligation bond is one that is backed by the city’s taxing power, also known as its full faith, and the city’s credit — its ability to borrow, instead of revenue that is derived from a specific activity or project. No assets are used as collateral. This type of bond usually finances projects that normally don’t provide the city with a direct source of revenue, such as roads, bridges and parks.

An example of a tax-backed bond lies with the Downtown Development Authority and the $55 million issuance it made to help finance the $75 million construction of Van Andel Arena. The DDA is meeting that debt service with its capture of voter-approved school millages, which guarantees bondholders their payments. Wallace said another example is the operating millage that the city’s public library system uses to pay for capital improvements.

“The city of Grand Rapids has no such specially designed millage, although we do allocate a part of our general property tax revenue for capital projects and debt,” she said.

So does Kent County: Its capital improvements budget has used from 0.15 mills to 0.2 mills of its property-tax millage to finance those projects the past several years.

Wallace also pointed out that the debt service for the city’s various parking ramp projects is paid for with revenues generated by Parking Services. She said that revenue source essentially doubles the backing for those bonds, since it is added to the full faith and credit pledge the city makes to bond buyers. The city issued $7.3 million in American Recovery and Reinvestment Act bonds to help fund the ramp at The Gallery at Fulton.

An essential services bond is usually sold to raise funds for wastewater management systems and utilities, with revenue from those systems used to pay the debt service. The city sold two bonds just before the end of last year. The receipts from those sales are being used to extend and improve the sanitary sewer system.

“Most of the city’s non-general obligation debt is issued on behalf of our water supply system and sanitary sewer system, both of which are considered essential services. Debt service for water and sewer bonds are supported by water and sewer system revenue,” said Wallace.

So a constant source of dedicated revenue from taxes or service charges, along with a unit’s ability to borrow, has made municipal bonds a fairly safe investment for those looking for a nearly guaranteed payback.

One reason the market should remain on solid footing for at least the foreseeable future is that interest rates are likely to remain low for as long as the Federal Reserve keeps its current policy in place. Another is a recent report from Standard & Poor’s that claimed the number of AAA-rated counties in the nation rose from 42 in October 2006 to 67 at the end of last year — a gain of nearly 60 percent during the years that marked the Great Recession.

“It should also be reassuring to you to know that the city of Grand Rapids has been rated double A by both Moody’s and Standard & Poor’s. Further, the city of Grand Rapids is a double-A-rated city located in a triple-A rated county,” said Wallace.

“Your city and county officials work very hard to manage our financial resources well.”

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