Municipal Bond Forum
Why defaults are rare
Q
I have been told that certain municipal bonds contain a clause that requires the issuer to pay bond debt before all other local expenses. Is this the case? If so, how can I decide which offerings have such a clause?
A
James A. Klotz responds:
Most municipal bonds contain security pledges that place payment of the debt as a first lien on revenues received by the issuer. This may not be universally true, but holds for both general obligation and revenue bonds. This structural priority of lien is partially responsible for the low default rate for municipal bonds and their wide popularity. How this structure is implemented varies from issue to issue. To determine the exact methodology used in a specific issue, investors need to review the Official Statement accompanying the issue where the security provisions of the bonds are described. Rating agency reports released at the time of issuance also describe the priority of debt service payment lien since this is a principal rating factor.
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