On Tuesday, Jefferson County, Alabama filed for bankruptcy, earning the dubious distinction of being the largest municipal bankruptcy in U.S. history.
The county was in debt to bondholders for more than $3 billion for a sewer system project, Bloomberg News reported on Thursday in the story, "Biggest muni bankruptcy ever puts investors on high alert."
Last year, the municipal bond market was rocked by predictions of devastating municipal defaults. Those predictions have largely gone unfulfilled.
From the story on Bloomberg.com:
This year through September, the number of municipal defaults fell to 42, totaling $949 million, from 79 in the first nine months of 2010, amounting to about $2.89 billion, according to the Distressed Debt Securities Newsletter, published by Miami Lakes, Florida-based Income Securities Advisor Inc.
Though the level of municipal defaults has remained stable, Jefferson County's bankruptcy filing highlights the risk of investing in municipal bonds and other securities.
Jefferson County's sewer project bonds are a type of muni bond known as revenue bonds. The other type of municipal bond is called general obligation. According to the website, Publicbonds.org, revenue bonds can be riskier because repayment is based on an income stream from the project the bonds are issued to finance.
For instance in Jefferson County's case, residents were expected to pay increasingly steep sewer fees to cover payments to bondholders. For lower income residents of the county, representing nearly 70 percent of the sewer uses according to Bloomberg, the fees became nearly unaffordable.
The good news is that, according to Publicbonds.org, municipal bankruptcies rarely lead to complete losses for bond holders.
Often, a default could result in the suspension of the coupon payment. Defaulted bonds can become speculation as they can be purchased fairly cheaply. If the issuer files for bankruptcy but reemerges successfully, then anyone who purchased the bonds when the company was in default stands to gain from the transaction.
Investors interested in municipal bonds should investigate the credit rating of the municipality before investing. But that's not all. A study by Fitch Ratings in 1999 found that management practices also have a predictive quality when it comes to debt repayment.
According to the Publicbonds.org website those practices are:
- Superior disclosure.
- Maintaining rainy day funds or operating reserves.
- Implementing debt affordability reviews and policies.
The website for the Municipal Securities Rulemaking Board provides information about the official statements on municipal issues as well as continuing disclosure information. An official statement is analogous to a prospectus for mutual funds.
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