With thousands of municipal bonds in the market, none are more important than yours. So when the economic climate becomes difficult, investors naturally wonder how we – and they – keep abreast of developments that may affect their holdings.
Although surveillance of outstanding municipal bonds can be challenging, it is a job we relish. Having previously served as head of issue surveillance at Standard & Poor’s, I am in a unique position to understand investor questions.
Improved disclosure
Surveillance and review of municipal bonds relies heavily on disclosures provided by issuers. Unlike corporate bond issuers, who are required to file numerous detailed reports with the Securities and Exchange Commission’s Edgar Database, gathering disclosure filings by municipal issuers can often be difficult. Fortunately, municipal bond disclosure practices have improved in recent years, but enforcement could be improved. Nevertheless, many issuers, especially larger or frequent borrowers, do provide regular updates on finances and other data that is essential to determining their ongoing performance.
A major source of information comes from the rating agencies. Issuers with ratings are required to furnish updated information on a continuing basis. Failure to do so can result in the suspension of an issuer’s rating.
The ongoing surveillance process at the rating agencies poses a bigger challenge than the new issue rating process since there are an estimated 18,000-plus outstanding rated issues.
About half the issuers have their ratings reviewed regularly since they issue debt fairly often, and any new bond ratings require a review of the older ones.
The timing of these reviews depends on how concerned the rating agencies are that there may need to be an adjustment. Certain market sectors, such as health care or long-term care, may be reviewed more often since the dynamics of those sectors are more volatile and sudden changes in their financial picture can impact payment of debt to a greater extent than for a general government bond.
Other sources of data about bond issuers are “repositories” where issuers file financial reports. These include the MSRB’s “Emma,” Dacbond.com, and Bloomberg Information Services. Filing requirements and the issuer’s promise to comply are detailed in a disclosure document that appears at the end of the “Official Statement” accompanying every bond issue.
Municipalities typically post budgets and Comprehensive Audited Financial Reports (CAFRs) on their Web site or make them available through the city’s finance department. These CAFRs contain audited financial statements, comments from city officials and a statistical section with historical information on the economy, tax collections and debt ratios.
The Government Accounting Standards Board (GASB) publishes an excellent guide for investors on how to read and analyze a CAFR.
In our research department at FMSbonds, we utilize all the above sources to remain current on the bonds we hold in our inventory and those we have previously sold to clients.
Muni ratings more stable than corporate cousins
As we have pointed out before, the municipal bond market has enjoyed greater rating stability than the corporate bond market.
Since muni bonds are long-term instruments, changes in an issuer’s financial or economic profile must be evaluated as to whether they are permanent, or represent a one-time blip in an otherwise creditworthy history.
In other words, while we want to alert our clients if we believe a bond issue they hold is having serious problems, we don’t want to urge a sale of these securities when we believe an issuer is experiencing a temporary rough patch and can be expected to return to a healthy financial profile in the future.
Once again, unlike their corporate cousins, muni bond issuers rarely go out of business, and their default rate remains extremely low. Nevertheless, we approach each issue from a long-term perspective with the understanding that the vast majority of muni bonds will continue to provide investors with the steady return of principal and interest they expect.