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Municipal Revenue Bonds Can Be Extremely Risky
Investors believe municipal bonds are safe. Most are, but some are extremely risky.
So-called "GO" bonds are general obligations of the municipality. The default rate is about one-third of 1% because the municipality backs them.
However, so-called "revenue bonds" do not have this broad backing. Instead, investors are paid principal and interest only from the revenue that the particular project, for which the bonds were issued, generates that revenue. Typically, projects include bridges, sewer systems and highways.
But the projects also can extend into more speculative ventures, amounting to nothing more than tax exempt corporate financing to which the municipality lends its name. Examples include industrial development bonds, healthcare bonds and multifamily housing bonds. These financings can mislead investors, who are taking equity-like risks without the benefit of equity-like returns.
These higher risk muni bonds usually come to market without a rating from a credit agency, and are about 10 times as likely as high-grade muni bonds to default. The default rate, according to a 1999 study, is 3% to 4% for non-rated and below investment grade muni bonds - including a nearly 15% default rate for industrial development bonds.
The risks can be extreme. For example, mutual fund manager Heartland Advisors, Inc. invested in non-rated munis and saw the share prices of two of its funds tumble 70% and 44% in one day. Those funds now are in receivership as a result of a court order that the SEC obtained.
Source: Wall Street Journal, March 28, 2001
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