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PROBLEMS IN MUNICIPAL BOND ISSUES GROWING
OUT OF THE METHOD OF RATING BONDS
Louisiana Conference on Municipal Finance and Adm i M ©tration
Louisiana S ta ta IMI v a r s ity
Panel Discussion of MProblems la Municipal Bond Issues
Growing Out of the Method of Sating Bonds*” February 36* 1953
Remarks by Tmym’ù à 1* Beagren, Deputy Chief
Division of lesearch and statistics
Federal Deposit Insurance Corporation
Ibis panel discussion* it should be acted, caster® os problems
which Btm fro® the rating of municipal securities with respect to their
investment quality*
Important ecoaoaic facts bearing upon the quality of
certain individual municipal issues la Louisiana have been stressed by some
of the discussants*
libere have bees observations concerning difficulties
involved is the administration of finance® by local governments*
Also,
your attention has been called to the m a y different classes of investors in
municipal securities*
Ubey incline iodividimi buyers, the various
categories of Institutional Investors, such as insurance companies and
pension .fund®, and the commercial basks*
lach category of investor ha® M s
own peculiar requirements quality-vise and in other respects*
Throughout
the discussions, emphasis has been placed upon the importance of precise
determinations with respect to credit quality*
When qualitative ratings do
not properly reflect the basic facts, the results are unfortunate both for
municipal finance officers confronted with the problem of managing a debt,
and investors who are seeking an outlet for funds*
Within the framework of this discussion, It will be my purpose to
outline the position of municipal bonds among bank assets*
This will be
followed by a few comments regarding type® of securities which are deemed
suitable for bank investment purposes*
Also, these remark® will include
some of the principal consideration® in determining credit quality*
Commercial Bank Investments
Commercial banks are chiefly concerned with financing the current
needs of trade and industry*
Generally speaking, their deposits comprise
the liquid resources of the community.
In managing its affairs# the
caaoerelal bank is obliged to select its assets In the form of loans and
Investments so that it will be in a position to meet the demand® of
depositors as they arise*
Accordingly# bank examining authorities are
quite Interested la the structure of bank assets m w e n as the nature of
the deposit liabilities and the margin of protection afforded by the
capital accounts*
Torn investment portfolio of a commercial bank is designed to
provide lodgment for that portion of its deposits which is considered to be.
relatively ®tabie~~that is# which turn over at a rather slow rate*
Accordingly# for practical reasons in facilitating management# the rules
& M standards for ©electing these investments have tended to become m m or
less rigidly established*
Municipal securities are appropriate for the
bank portfolio only to the extent that they conform in gen eral to the
requirements for bank investments*
If a municipal security i s to be deemed suitable for bank
investment purposes# It must be able to support itself firmly on. two very
stout legs*
First of all# it is necessary for the security to have a
quality which Is appropriate for the bank*® portfolio.
Secondly, it must
possess the other appropriate investment characteristics such as maturity#
yield# and marketability*
m % **
Wlmt, then, are the qualitative requirements for municipal
securities in the bank portfolio?
The answer to this question Is dictated
by the basic importance of the commercial bank to the economic life of the
eosiauaity, and the bank's obligation to protect the liquid resources of its
depositor®.
the qualitative standards for bank investment in municipal
securities are high*
Municipal securities of inferior quality are not appropriate for
bank investment purposes*
they may, of course, be suitable for commitments
by other classes of investors.
Some of them, for example private investors,
have very different investment requirements*
They way be in a position to
accept the risks of uncertain situation® which may entail temporary delay
la interest payments, and even a reorganisation of the entire debt structure
of the borrower« Banks, however, because of the peculiar nature of their
obligation to depositors, are not in a position to accept such risks.
Capital margins of commercial banks are small.
On the average,
the capital margin m v amounts to about 1$ of total resources for all
insured commercial banks.
Banks are always under the compulsion of
investing in assets for which the risk of loss is minimised.
But private
individual® and most institutional investors are not circumscribed by the
pressures of narrow capital margins and large deposit liabilities.
For the
most part, son-bank investors are in a better position than banks to
shoulder the uncertainties of investment in securities of doubtful or
inferior quality.
There is still another reason why, as a practical matter, bank®
are obliged to confine their commitments to the best quality of municipal
m % m
securities«
Top quallty issues mm retatively easy te identify and tia
process d œ s not Inveiva oomplicated or extensive Investment rsaearch*
Furtheiaore, investment researeh is eostly business and only the larder
feaafce can afferà to engage la vork of this nature«
Ho doutt an exhaustive
study of aany different municipal securitie® uould disclose some vhose
^usüLlty vas not properly identified.
îiovever, this type of reeearch can
beat be ucdertaken by private individual® or highly specialised
institutionai Investors«
Tfeey eau afford to spead the timm needed to find
urmsual investment opportuni tic s.
As preface to a discussion of thè questioni
Kow are municipal
seeurltlaa selected for a bank Investment portfollot it eould som.
appropriate to coassent briefly on the great variety of Securities avallarle
in the investment market.
Biere arc literally thousands of different
Igsuers of municipal securities.
These securltie® range from notations of
the a a U unit® of goveroaent to thm obligations of the large st citiez and
State® in the Hation«
varied»
The purposes for issulng the aecurities are rnany and
The Investor in municipal aecurities aay choose aaoog obligations
uhich represent a pledge of the full faitk and credit of the 1teuer and
fietattoos for very special purposes* the debt service of ehich dépends
upon the onteone of specific type® of eaterprlse«
8®m o t the
mmI d p e l securities are vell-kaoeo in the national market® but the bulk of
thm are outstaa&lng in small assount® and tmkmm beyond the place of issue.
^naiysia ot Investment Quality
ln the management of ite municipal portfolio the individual bank
is obliged to select issues of appropriate quality fremi this vide and
5
varied area of investment*
fhe process of selection# if it is to be
successful# first rests upon a detailed study of the pertinent Investment
factsJ and in the second place# Involves an exercise of sound jwdipent In
the light of knowledge*
The application of high qualitative standards facilitates the work
of selecting municipal issues for bank investment purposes*
In analysing
the data pertaining to municipal credits# it is comparatively easy to
identify the ones of high quality# providing the essential information Is
available*
However# many municipal issues are floated by small units of
government which do not compile and publish all of the facts needed for
purposes of Investment analysis*
Furthermore# the interpretation and
analysis of the essential information requires both knowledge and experience
In this field*
The analyst# in judging the credit quality of a municipal issue#
focuses his attention on this questions
debt successfully?
Can the municipality manage its
Consideration is given to the previous financial record
of the issuer in arriving at an answer to this question*
finance there Is a remarkable degree of continuity.
In municipal
Broadly speaking,'
¿soundly managed communities tend to remain in that category*
On the other
hand# where financial management has not followed the beet practices#
improvement comes about rather slowly*
As a consequence# the financial
record is always of very great importance.
Parenthetically# it should be noted that the validity of a
municipal security is a matter of fundamental importance to the analysis of
investment quality*
However# the legal statue of the issue can only 'be
determined by those qualified to pass upon questions of municipal law.
Accordingly, t o analyst as a preliminary to his work seeks and accepts m
opinion regarding the legality of the issue from qualified attorney0«
An analyst of a municipal credit ale© is obliged to give
a tten tio n to the current financial status o f a municipality whose credit Is
being studied*
At this point the analyst is interested in audits covering
the finances of the municipality*
What do the receipts and disbursements
show with regard to a municipality*s current financial condition!
If the
past record is good and the current statements show that the authorities
ere making adequate provision for the various financial requirement®,
including the managesier.it of the debt, t o r e is coasiderahl© assurance o f
the credit quality*
The future prospects for a municipality have m Important bearing
upon the credit quality of its securities.
fo re ca sts of this sort*
It is not easy to prepare
they rest, however, upon an appraisal of t o facts
regarding the basic strength of the am m ay and the current developments*
The skillful analyst is t o one who can detect q u ick ly the favorable and
unfavorable trends, and who has sufficient imagination to translate them
into a qualitative Judgment*
In connection with the analysis of municipal securities for t o
purpose of determining credit quality, a number of tests have been
developed m clues or shortcuts.
It is a fact that many o f these tests
serve a useful purpose in the analytical process*
However, shortcut tests
have not proved to be a substitute for sound Judgment.
only for very limited purposes*
The
test is useful
Among the tests applied to municipal ©ecurltles in Judging
quality, there are the so-called standard ratios each as the ratio of debt
to assessed value and the per capita debt,
cosapota.
^sese ratios arc easy to
!Ehe amount of outstanding debt can be determined and reports are
a v a ila b le as to the assessed value of property.
docs oat give an automatic answer.
But the resulting ratio
It merely serves as a device for
comparing one situation with another.
interpret the meaning of the
ra tio calls for a basic understanding of a credit, in other words, for a
complete analysis.
Similarly, the ratio of debt to the number of
inhabitants in the area is easy to compute, but here again, interpretation
c a lls fo r much more knowledge.
value.
The ratio standing by itself i s of no
At beat, it furnishes a means for comparison*
At this point it would seem appropriate to make a few comments
regarding the area of agreement with respect t© th e quality o f most issue®
o f municipal securities,
there is little disagreement by analysts
regarding the securities of good quality or those of inferior grade.
However, the marginal cases present exceedingly troublesome problems for
the analysts who are undertaking to Judge the quality o f municipal
s e c u r itie s .
It has been my experience that something can be doss to d e a r up
these difference© of opinion about credit quality In the marginal caees.
For cxmspXe, very frequently the differences o f opinion ©tern from a basic
lack of information.
When additional information is forthcoming or
information In greater detail, it is frequently possible to remove a
se cu rity from the marginal category end move it into one or the other of
iftÉ
Bxmm of agrecænt.
Thm there are case® «haré a study o f the baaie
crédit discloses that raiher sisals remédiai measurea cas lirisg ©bout as
«sr«w*8fc or¿ crédit qualité*
la tha methods and w&wits
Sometía©»
o î tax levtss or iisprovemçmts la tha ssanageaent ©f aasesfMtnt rolle are
cufficient to briag a crédit from th® doubtful or aarglnal category lato
tm ©tatas of a atrong municipal obligation.
l^ægaagy aa& Conclusion
To mm *jÿ tben* it ®femsM be reeog&laad at tha o u t œ t la thla
discasalon o î qualitative ratings for municipal aaeuritias tkat tha
aadards for investment© «^ropriate for ba»k portfolios are M g b .
Bsak©
are osly ona of tha saay classes of iavestors seekiag outlet for tfeeir
funds in this type of secnrity*
IShsy hâve vary défiait® limitations on
tfeaùr aetivities.
îa deteralning the lavastmat quallty of a municipal issue# tha
©¿¿alysts ©entera on tba question»
sueeessfully?
Cmi the o b U g o r
the debt
Although there la a groat variété of analytleal tooie in tha
to m of ratios and oiher statistical measures, there la no sustituto for a
Judgaetst procesa basad upon a stody of tha pertinent facta.
î t i® o f utmost Impertan©© that tfea municipal © fficer recogEiüe
tlie investtsant requlremente o f tha varions classes o f Investors efeos# îvmâ®
are eow dtted to municipal obligation© .
For the parpóse© o f th ia discussion
attention bas beer» eeotered upon the very narrov requiroment© fo r .tank :iavaatmaot.
Adéquate reports presentlsg th© essential facts bearlng upoa the
affair© of a œanicipality are of graat traporta»e© lu dataxwLalag the
.
mH
I 9B i .
S
;
$ £ i$ :
IPt .
■> iMfeara*•,
«* $ *
quality of a given issuer*
A municipal officer Is seXl-advised to develop
reports s t ic h facilitate investment a n a ly s is and take steps to sake copies
a v a ila b le to prospective investors*
Finally, there is so substitute fo r sound financial programs and
adherence to practices recognised as appropriate for muaicipalities if a
security is to have a place la a bask portfolio* or for that natter*
@1»«where i s the coesaunity o f in vesto rs*
"x-ri
MUNICIPAL SECURITY ANALYSIS
AND BANK INVESTMENT PROBLEMS*
A discussion of investment problems of banking institutions related
to the analytical techniques for judging municipal credit.
PiMisted16yM8HIQIPAL HIHAHCE OfFICtRS ASSOCIATIOK of the Uuted States and Canada, 1313 East 60th S t, Chicago 37, HI.
Special Bulletin 1 9 5 3 E
D ir e c tly or i n d i r e c t ly , a v e ry s u b s ta n tia l por
tion of the e f f o r t s o f a m unicipal fin an ce o f f i c e r
is devoted to problems touching upon the c r e d it
standing o f h is governm ental u n it .
F in a n c ia l man
agement and the r e f l e c t io n o f i t in r e p o rts are the
more oonspicious a sp e c ts o f t h i s work. But the f i
nance o f f i c e r in co n cen tra tin g a tte n tio n on manage
ment and r e p o rts i s concerned only w ith one sid e o f
the coin; the re v e rse sid e o f t h is same coin shows
the investment problem and the a n a ly s is o f s e c u r i
ties.
The background f o r t h i s d isc u ssio n o f the bank
investment problem and the r e la te d a n a ly t ic a l te c h
niques fo r judging mimici pal c r e d it w i l l be sketched
1by focusing a tte n tio n on two q u estio n s:
nk
(a) To what e x te n t do S ta te and lo c a l govern
ments r e ly on commercial banks fo r lo n g term c r e d it requ irem en ts, and
(b) How im portant are the o b lig a tio n s o f th ese
governmental u n its in the a s s e t s tru c tu re
o f the commercial banks?
The answer to the f i r s t q uestion w i l l suggest the
extent to which i t i s n ecessary to take banks in to
account.
Some in s ig h t as to the nature o f the
banks’ investm ent requirem ents w i l l be developed
from the answer to the second q u e stio n . To be su re ,
a finance o f f i c e r cannot shape h is e n tir e c r e d it
requirements to f i t the s p e c i f ic investm ent needs
of any one s u p p lie r o f fu n d s, but i t would be f o o l
hardy to ign ore the p la ce occupied by banks in the
Investment m arket.
How the technique o f s e c u r ity a n a ly s is i s used,
in judging c r e d it q u a lity f o r the purpose o f s e
a tin g investm ents w i l l a ls o r e c e iv e a good share
of our a tte n tio n .
The fin a n c ia l re p o rt coverin g
the operations o f a m u n ic ip a lity i s o f c r u c ia l im
portance in t h is a n a ly t ic a l p ro ce ss. An understand
ing of s e c u r it y a n a ly s is w i l l enable the fin an ce
officer to develop h is r e p o rt so th a t i t may be
osed e f f e c t i v e l y in s o lv in g investm ent problems,
.host important o f a l l , however, i t i s hoped th a t a
Jiiscussion o f a n a ly s is w i l l encourage continued im
provement in the q u a lity o f r e p o rtin g .
¡sed on a p a pe r given by Ra ymond E. H e n g re n o n June 2,
1953* at Miami, Florida, during the 47th Annual C o n f e r e n c e
I'the Municipal Finance Of ficers Associ at io n of the United
Mates and Ca nada.
Mr. H e n g re n is Deputy Chief, D i vi si on
P Research and Statis ti cs , Federal Deposit Insurance CorWration, Washington, D.C.
Opinions expressed in this bulstin are those of the auth or and not n e c e ss ar il y those of
Ms Assoc iat io n .
Price 50 Cents
August. 1953
Commercial Banks as S u p p lie rs o f C red it
to M unicipal Governments
Some grap h ic m a teria l has been prepared to
i l l u s t r a t e the answer to the f i r s t q u estio n :
To
what e x te n t do S ta te s and oth er governmental u n its
r e ly on commercial banks fo r long-term c r e d it? In
form ation regard in g the ownership o f s e c u r it ie s
issu ed by S ta te and lo c a l governments i s presented
in Chart I on page 4 » The data coverin g the period
1937~1952 were obtained from the 1952 r e p o rt o f the
United S ta te s S e c re ta ry o f the T reasu ry.
Columns
in one o f the panels o f Chart I d e p ic t the d o lla r
amount o f s e c u r it ie s o u tstan d in g .
Each o f the
columns i s broken in to segments in d ic a tin g the
major c la s s e s o f in v e s to r s . The r e la t i v e amount o f
s e c u r i t ie s h eld by each ownership segment i s pre
sented in the a d ja c e n t c h a rt p a n el.
From these data i t w i l l be noted th a t the v o l
ume o f outstanding m unicipal s e c u r i t ie s has now in
creased by n e a rly $10 b i l l i o n above the pre-war
l e v e l o f approxim ately $20 b i l l i o n .
M oreover, the
commercial banks have grown in s ta tu re as h old ers:
o f th ese s e c u r it ie s over the y e a r s .
The in crease
in the d o lla r volume o f t h e ir h old in gs i s q u ite im
p r e s s iv e .
At the p resen t tim e the banks have in
t h e ir investm ent accounts more than o n e -th ird o f
a l l ou tstan din g m unicipal s e c u r i t i e s . This p o s itio n
has been a tta in e d through a period o f stead y prog
r e s s from the pre-war le v e l o f about 15$ o f the
to ta l.
Furtherm ore, the tren d continues to point
sh arp ly upward.
As one point o f re fe re n c e i t i s in te r e s tin g to
observe th a t during World War I I the commercial
banks never held as much as o n e-th ird o f the ou t
standing F ederal o b lig a t io n s . To be su re , th is in
volved a much la r g e r amount than i s comprised by
the f r a c t io n o f m unicipal s e c u r i t ie s c u r r e n tly held
by the banks.
N e v e rth e le ss, S ta te s and o th er sub
d iv is io n s o f government today are le a n in g very
h e a v ily on the commercial banks f o r c r e d i t .
Changes in the r e la t i v e importance o f the d i f
fe r e n t c la s s e s o f in v e s to r s supplying m unicipal
c r e d it are worthy o f c a r e fu l study by the fin an ce
o ffic e r .
Here a tte n tio n has been concentrated on
the r o le o f the commercial banks, but the shrinkage
in the importance o f oth er in v e s to r groups should
not be ign ored . The long-run s ig n ific a n c e o f these
tre n d s, however, i s an i n t r ic a t e s u b je c t which may
have an im portant bearing on the e n tir e economy.
R elian ce by S ta te s and oth er su b d iv isio n s o f
government upon the commercial banks f o r c r e d it
makes i t important th a t fin an ce o f f i c e r s understand
the investm ent requirem ents and lim ita t io n s o f
banks. Commercial banks may w e ll be d escrib ed as a
unique c la s s o f in v e s to r s .
Q u alityw ise and in
oth er r e s p e c ts , the commercial banks have r ig i d i n
vestm ent requ irem en ts.
S p e c i f i c a l l y , t h e ir need
f o r r e a d ily a v a ila b le c r e d it inform ation i s more
e x a c tin g than o th e rs who in v e s t in m unicipal seou ritie s .
M unicipal S e c u r it ie s in
Commercial Bank P o r t fo lio s
Now l e t us lo o k a t our second q u e stio n :
How
im portant are m unicipal s e c u r i t ie s in the a s s e t
s tr u c tu r e o f the commercial banks?
C hart I I shown
on page 5 p resen ts data f o r the period 1957-1952
reg a rd in g the s e c u r i t ie s o f S ta te and l o c a l govern
ments held by commercial banks.
T h is inform ation
was compiled by the F ederal D eposit Insurance Cor
p o ra tio n .
Both the d o lla r amount o f the h o ld in gs
and the percentage o f t o t a l re so u rce s committed to
th ese s e c u r it ie s have been p ic tu r e d .
With h o ld in gs which now aggregate alm ost # 1 0
b i l l i o n , commercial banks have in creased t h e i r i n
vestm ents in the o b lig a tio n s o f S ta te s and lo c a l
governments by alm ost #7 b i l l i o n over the le v e l in
the y e a rs b efo re World War I I .
By r e fe r r in g to
Chart I i t w i l l be noted th a t the volume o f o u t
standing m unicipal s e c u r i t ie s exceeds the pre-war
l e v e l by about # 1 0 b i l l i o n .
Thus i t appears th a t
an amount equal to about #7 b i l l i o n o f th e #10 b i l
lio n in cre ase in ou tstan ding debt volume has found
lodgment in the commercial banks. T h is i s a d e v e l
opment which c e r t a in ly i s worthy o f sober thought.
The rap id post-w ar growth in commercial bank
h o ld in gs o f m unicipal s e c u r i t ie s has g iv e n r i s e to
much comment in the f in a n c ia l p r e ss . From Chart I I
i t i s apparent th a t in r e l a t i v e terms the s iz e o f
the p o r t fo lio i s not w ith o u t p reced en t.
P r io r to
World War I I banks committed about 5% o f t h e ir total
reso u rce s to m unicipal s e c u r i t i e s . In the war y ea rs
the commitment d e clin e d to a low o f about 2^% o f
t o t a l r e s o u rc e s. Since th en , however, the reco very
has been rap id and now the percentage has returned
to the pre-war l e v e l .
However, commercial banking
re so u rc e s have grown to about #185 b i l l i o n , and 5%
o f the t o t a l com prises a m unicipal p o r t f o lio ap
proxim ating #10 b i l l i o n .
There i s no reason to b e lie v e th a t 5% i s a
standard f o r the amount o f commercial bank resources
to be in ve ste d in m unicipal s e c u r i t i e s . As a m atter
o f f a c t , the p ro p o rtio n may v e r y w e ll clim b h ig h e r,
j u s t as in r e c e n t y e a rs i t has d eclin e d to a much
low er f ig u r e . T h is r a t i o depends r e a l l y on banking
co n sid e ra tio n s and not upon h i s t o r i c a l p reced en t-in p a rt upon the a v a i l a b i l i t y o f funds in the com
m ercial banks which may be committed to investm ent
s e c u r i t i e s , and in p a rt upon the e x te n t to which
t h is c la s s o f o b lig a tio n s measures up to the in
vestm ent requ irem ents.
Bank P o r t fo lio Management
A lo o k a t our s u b je c t from the view p oin t o f
those charged w ith r e s p o n s ib ilit y fo r the manageiment o f bank investm ents w i l l be the n ext step in
t h is d is c u s s io n .
The q u a lit y o f m unicipal s e c u r i
t i e s deemed to be s u ita b le f o r bank investm ent pur
poses w i l l be considered f i r s t .
This w i l l be f o l
lowed by a few o b serv atio n s re g a rd in g bank r e q u ir e
ments f o r a schedule o f m a tu r itie s in the investment
p o r t f o lio and f o r the m a r k e ta b ility o f the s e c u r i
t i e s . F in a lly , some c o n sid e ra tio n w i l l be g iv en to
d i v e r s i f i c a t io n o f item s in the p o r t f o lio .
p ie q u a lit a t iv e standards fo r investm ent s e
c u r i t i e s h eld by the commercial banks are v e ry high.
These high q u a lit a t iv e standards stem from the*
nature o f commercial banking. Banks hold the liquid!
re so u rces o f the communities th ey serve in th e 0form!
o f d e p o s its c re d ite d to th e ir custom ers.
As ai
p r a c t ic a l m a tter, most o f the d e p o s its are p a y a b le /
upon demand, although some are s u b je c t to time rgWy
s t r ic t ! o n s on w ith d ra w a ls.
I f economic tragedy f{l
to be a v e r te d , the a f f a i r s o f oom nercial banks must!
be so managed th a t d e p o s ito rs can be paid when theyi
req u est t h e ir d e p o s its .
In managing the re so u rces o f a bank, experi-'
ence has demonstrated th a t p a rt o f the a ss e ts may
p ro p erly be in vested in s e c u r i t i e s .
These invest
ments, however, are viewed as a ready source ofi
cash should th e need a r i s e . As a consequence, theyi
cannot be s u b je c t to v a lu e d e t e r io r a t io n .
While]
high investm ent q u a lity by i t s e l f may not be suffic ie n t to prevent the e ro sio n o f a s s e t v a lu e s , i t is
one o f the in g re d ie n ts which to g e th e r w ith other
elem ents w i l l preserve v a lu e s .
Other c la s s e s o f in v e s to r s are not subject to
the same p ressu res as those which impinge on banks?
to fin d s e c u r i t ie s o f top q u a lit y .
O bligation s of]
o rd in a ry , or f o r th a t m a tter, even m arginal quality*
fre q u e n tly o f f e r a t t r a c t io n s to non-bank investors,!
such as p r iv a te in d iv id u a ls .
Elements o f uncer
t a in t y which may not have been p ro p erly discounted!
in market p r ic e s o ften fu rn ish p r iv a te in vestors an]
op p ortun ity f o r p r o f i t .
But the r is k s inherent in
th ese s it u a t io n s are such th a t the opportunities,
can never be a t t r a c t i v e to the commercial banks, 1
ar
Ir
th
an
gr
te
lo
re
ho
wi
po
ma
he
lo
mu
ma
Fo
it
be
fo
Bu
or
mu
At tim es m unicipal fin a n ce o f f i c e r s may feel
th a t commercial banks are unduly apprehensive about
the q u a lit y o f s e c u r i t ie s in the m unicipal port
fo lio .
Bank investm ent managers, l i k e municipal
o f f i c i a l s , are o b lig e d to m aintain a p u b lic view-*!
p o in t. To them, the bank investm ent s itu a tio n c
not be view ed as a p r iv a te a f f a i r . The in te r e s t
the p u b lic g e n e r a lly i s a t stake and th ere i s | 8
a lt e r n a t iv e but to commit bank funds to securities?
which measure up to the high q u a lit a t iv e standards)
which w i l l avoid m isfortune f o r the community asf
w e ll as the in d iv id u a l bank.
In the m atter of I ag
q u a lity th ere i s no room f o r compromise.
To do so! in
i s a c e r t a in step in the d ir e c tio n o f misfortune,! ca
at
N ext, l e t us turn to a co n sid e ra tio n o f matur-J PO
i t y sch ed ules and m a r k e ta b ility f o r the items
cr
the m unicipal p o r t fo lio o f a bank.
In each indi-i do
v id u a l commercial bank th ere i s a ch aracteristic
sc
ebb and flo w o f fu n d s.
At tim es funds tend to ar
accum ulate.
Then, in oth er p e r io d s, they shrink,; in
T h is flu c tu a tio n in the amount o f bank funds is re fa
f le c t e d c h i e f ly by changes in the d e p o s its , loans,) co
and in r e s e r v e s .
\ mu
Because the managers o f bank investm ent port-v
f o l i o s are e s p e c ia lly consciou s o f the ebb and flow]
in d e p o s its and re q u e s ts f o r lo a n s , they endeavor]
q u ite s y s te m a tic a lly to b u ild in to t h e ir investment!
programs c e r t a in fe a tu r e s which w i l l make cash
a v a ila b le to them a t the proper tim e.
This is ac-)
complished by s e le c tin g bonds' whose m a tu ritie s are)
expected to co in cid e w ith the time when an outflow/
o f funds i s a n tic ip a te d .
Each bank has i t s ownf/
r a te o f tu rn -o v er in d e p o sit accounts as w e ll as a)
p a ttern o f a c t i v i t y in the demand fo r lo a n s.
Ac-■;
c o r d in g ly , the schedule o f m a tu r itie s i s adjusted;
in conform ity w ith th ese a n t ic ip a t io n s .
]
m
The f a c t th a t d e p o s its in a commercial banel
o r d in a r ily do not remain undisturbed fo r a longp
period o f time i s one o f the im portant reasons w|y|
managers o f bank investm ent p o r t fo lio s do not look 1
w ith fa v o r upon s e c u r i t ie s which mature in the!
ec
j©
tu
de
in
sc
in
af
le
of
su
ni
ve
°®| the1 d ista n t f u tu r e .
A ra p id tu rn -o ver o f investm ent
liquid funds through the m atu rity schedule p rovides the
he formj commercial bank w ith a stead y in -flo w o f cash .
If
As a I the funds are needed to meet w ithdraw al o f dep osits,
payablei they are a v a i la b le .
Should they not be needed f o r
rBjj®his purpose, the p o r t f o lio manager may, o f cou rse,
?eay
in v e st them.
kb must
sn they
High q u a lity investm ents in a bank p o r t fo lio
are not a s u b s titu te f o r a p p ro p riate m atu rity dates.
Irre sp e c tiv e o f q u a lit y , i t i s a m athem atical f a c t
a x p e ri -1 that changes
in the p r e v a ilin g r a te o f retu rn on
3 ts may
any c la s s o f investm ents, cause
p ro p o rtio n a te ly
in v e s t-' greater flu c tu a tio n s in the
c a p ita l va lu e o f lo n g
uree of' term than sh ort-term I s s u e s .
To avo id the r i s k o f
3 , they'. loss in c a p it a l v a lu e s ,
th e r e fo r e , i t i s a w e ll While recognized
te n e t o f bank investm ent p o lic y 'th at
s u ffiholdings should be con fin ed to s e c u r i t ie s which
» i t is w ill mature w ith in the
n ext few y e a r s ,
A bank
i other p o r tfo lio
o f sh ort-term o b lig a t io n s , f o r example,
maturing w ith in a period o f f i v e y e a r s , has an in
herent v a lu e -s u s ta in in g elem ent th a t i s absent in
j e c t tol long-term is s u e s .
i banks?
Lons of j
lu a lit y
J sto rs,
uncer-j
jounted
to rs an:’
'e n t in
m itie s ?
ik s .
I
While i t I s p o s sib le to co n vert a p o r t fo lio o f
municipal s e c u r i t ie s in to cash through s a le s in the
market, t h a t , as a g en eral r u l e , i s not p r a c t i c a l .
For the most p a r t, tr a n s a c tio n s in m unicipal se c u r
i t i e s in v o lv e more or l e s s e x te n siv e n e g o tia tio n s
between buyers and s e l l e r s . To be s u r e , the market
for many o f th ese o b lig a tio n s i s broad and a c t iv e .
But there i s a v a s t number o f is s u e s , and form al or
organized exchanges have not developed f o r tra d in g
I m unicipals.
„
r feel
> about
There are c e r ta in c la s s e s o f in v e s to r s oth er
port- ] than banks, namely, p r iv a te in d iv id u a ls or pension
îicipal I funds, who need not be concerned w ith m atu rity
i view-i schedules.
They can a n tic ip a te t h e ir requirem ents
>n ce
ver long p e rio d s o f tim e.
Very fr e q u e n tly , they
■ est
!eed investm ents which w i l l remain u n disturb ed.
is ncT-But commercial banks have an e n t i r e ly d if f e r e n t
ndardsj Pro^®m» They need sh o rt m a tu r itie s , not long ones.
d t y as'
;e r of |
• do so I
>rtune, j
ma tur- J
,ems inJ
. in d i-I
r is tia
e n d to
h r in k . !
i s re-j
lo a n s,]
port-?
d flow!
deavor i
stment
cast
i s ac-|
e s arei
utflowj
s ownfr
1 as at
Ac-!
justedj
A few o th e r b a sic co n sid e ra tio n s in the man
agement o f a bank investm ent p o r t fo lio are d eserv
ing o f d is c u s s io n . The p r in c ip le o f r i s k d i v e r s i f i
cation i s one th a t fre q u e n tly r e c e iv e s co n sid erab le
a tte n tio n . I t i s c e r t a in ly d e s ir a b le to b u ild up a
p o r tfo lio from item s which re p re se n t as broad a
c re d it base as p o s s ib le . D iv e r s if ic a t io n , however,
does not mean th a t a bank p o r t fo lio w i l l in clu de a
s c a tte rin g o f commitments o ver a la r g e geo grap h ical
area. I t e n t a i ls a f a r more s o p h is tic a te d approach
in the s e le c t io n o f s e e x ir itie s .
As a m atter o f
f a c t , d i v e r s i f i c a t io n s fre q u e n tly i s achieved by
confining investm ents c h i e f l y to the o b lig a tio n s o f
m u n ic ip a litie s w ith a stro n g and w e ll- d i v e r s i f i e d
economic background.
Income from m unicipal s e c u r it ie s i s not sub
je c t to F ed era l income ta x e s . This ta x exempt f e a
ture i s e s p e c i a lly a t t r a c t i v e to banks because they
derive earn in gs c h ie f ly from i n t e r e s t on loan s and
investm ents.
However, i t i s not c o n s is te n t w ith
sound p r a c tic e s f o r a bank to maximize i t s t a x - fr e e
income by co n cen tra tin g investm ents in m unicipals
a fford in g the h ig h e s t y i e l d .
When bonds are s e
lected f o r in c lu s io n in ,a p o r t f o li o , y ie ld i s one
of se v e ra l im portant c o n s id e r a tio n s. Other f a c t o r s ,
such as q u a lit y and m a tu rity , a ls o are im portant.
ban|ft
long”
ns
ti
M unicipal S e c u r ity A n a ly sis
Knowledge o f m unicipal s e c u r ity a n a ly s is te c h niQues and o f the p a rt a n a ly s is p la y s in the in
vestment p ro cess may be u s e fu l to the m unicipal f i
3
nance o f f i c e r . Viewed narrow ly, h is a c t i v i t i e s in
th is area are lim ite d to the p reparation o f rep o rts.
Good fin a n c ia l r e p o r tin g , however, lin k s s e c u r ity
a n a ly s is and bank investm ent in m u n icip als. A naly
s i s fu rn is h e s a r a t io n a l b a sis f o r guiding d ecisio n
when i t i s n ecessary to s e le c t investm ents among
the many a lte r n a tiv e s a v a ila b le in the m arket.
To cover the s u b je c t o f m unicipal s e c u r ity
a n a ly s is s y s te m a tic a lly and in d e t a il i s f a r too
am bitious a ta sk in t h is d is c u s s io n .
But i t i s
p r a c t ic a l to sketch the broad o u t lin e s . Exhaustive
treatm ents o f the s u b je c t may be found in the
standard textbooks covering the f i e l d o f in v e s t
ments .
M unicipal s e c u r ity a n a ly s is i s not a cut-an ddried procedure and th ere are no pat answers to the
b a sic q u estio n s.
I t i s an em p irica l and p r a c tic a l
technique designed to h elp determ ine the s u i t a b i l i
t y o f a s e c u r ity f o r investm ent. S e c u rity a n a ly s is
i s s c i e n t i f i c in the sense th a t i t i s based on ob
se rv a tio n and o r d e r lin e s s o f stu d y.
U ltim a te ly ,
however, a n a ly s is i s an a r t because i t in v o lv e s a
chain o f d e c is io n s eaoh o f which r e s t s upon q u a li
t a t iv e jxidgments.
Although i t i s n ecessary to r e
view the b a sic inform ation in any case sy stem a ti
c a l l y , th ere i s no e s ta b lish e d formula to be f o l
lowed in a n a ly s is . The f i n a l answer i s a composite
judgment supported by many in term ediate determ ina
tio n s .
Faots to support th ese determ inations f r e
q uen tly are in c o n c lu s iv e .
Far too o fte n they are
im possible to o b ta in .
L ater on, some re fe re n c e w i l l be made to the
a p p lic a tio n o f reco gn ized investm ent standards in
the p rocess o f m unicipal s e c u r ity a n a ly s is .
These
standards are u s e fu l fo r measuring the s ig n ific a n c e
o f d a ta . They have grown out o f e x p e rie n ce . Never
t h e le s s , they should not be thought o f as immutable
y a r d s tic k s .
A p p reciation o f m unicipal s e c u r ity a n a ly s is
tech niques w i l l in orease the e f fe c tiv e n e s s o f a
m unicipal or oth er p u b lic fin a n ce o f f i c e r in manag
ing a d eb t.
I f he knows something about a n a ly s is ,
i t w i l l be much e a s ie r f o r him to assemble and make
a v a ila b le to the p u b lic g e n e r a lly the kind o f in
form ation requ ired by managers o f investm ent p o rt
f o l i o s . Moreover, the fin an ce o f f i c e r w i l l be able
to a n tic ip a te the e x te n t to which the o b lig a tio n s
o f h is governmental u n it w i l l be ap p rop riate fo r
bank investm ent purposes. The f a c t th a t some muni
c ip a l is s u e s cannot be expected to a t t r a c t bank
funds w i l l not come as a s u rp ris e to him because he
w i l l understand the rea so n s.
Undoubtedly there
have been tim es when a m unicipal fin an ce o f f i c e r ’ s
la c k o f knowledge regard in g the technique o f s e c u r
i t y a n a ly s is has re a c te d a d v e rs e ly fo r the c r e d it
standing o f h is m u n ic ip a lity .
The purpose o f m unicipal s e c u r ity a n a ly s is i s
to answer one simple q u estion : W ill the m unicipal
i t y pay i t s o b lig a tio n s in accordance w ith the
terms o f each in d iv id u a l bond is su e ?
There i s no
attem pt to ap praise the goodness o f c r e d it in any
ab so lu te sen se. S u ff ic ie n t fo r the purposes o f the
bank p o r t fo lio manager i s an informed opinion on
the p ro sp ects f o r investm ent performance.
The reason f o r narrowing the question to the
ou tlook f o r a g iv e n bond i s not hard to s e e .
Nor
i s i t enough th a t in the long run the c r e d i t o f a
governmental u n it w i l l be s a t is f a c t o r y .
D elays in
payment o f in t e r e s t or p r in c ip a l on a s p e c if ic
is s u e , even fo r a sh o rt tim e, w i l l make the o b lig a
tio n u n su ita b le to c e r ta in investm ent programs.
This i s e s p e c ia lly tru e fo r banks.
OWNERSHIP OF SECURITIES ISSUED BY STATE
CHART I
AND LOCAL GOVERNMENTS
BILLIONS OF DOLLARS
3 0 ------------------------------------------------------------------------------------------------- 30
PERCENTAGE OF TOTAL OUTSTANDING
20
—
—
20
1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952
ta
1301
1300
1303
I3 *»U
13*11
CHART II
I3 H £
I3 H 0 I9H H
IO«tU lOHO IO*frf
IOHO
10JÜ
lO ü i
IM W W
I WWW
IWT W
IWT I
I WV «_
SECURITIES OF STATE AND LOCAL GOVERNMENTS
HELD BY COMMERCIAL BANKS
BILLIONS OF DOLLARS
PERCENT
— 6
10 — -------------
DOLLAR AMOUNT
1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952
1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952
-
M unicipal s e c u r ity a n a ly s is in v o lv e s the s i f t
ing and a p p ra isin g o f economic and fin a n c ia l in f o r
m ation.
I t t r i e s to id e n t if y the c o n tr o llin g f a c
to r s w ith r e s p e c t to a p a r tic u la r s e c u r it y . In the
p rocess o f a n a ly s is the o b lig a tio n i s assumed to be
v a l i d . D eterm ination o f l e g a l i t y has developed in
to a h ig h ly s p e c ia liz e d branch o f the law .
As a
p r a c t ic a l m a tte r, investm ent a n a ly s ts are o b lig e d
to r e l y upon the f i n a l approving opinion o f a t t o r
neys who are n a tio n a lly reco gn ized e x p e rts in de
term ining the le g a l c h a r a c t e r is t ic s o f each bond
is s u e .
A fte r the a n a ly s t has s a t i s f i e d h im se lf
th a t the o b lig a tio n under c o n sid e ra tio n i s v a l i d ,
he then s e ts about to i s o la t e the c r u c ia l elem ents
b earin g upon investm ent stan d in g .
A review o f the economic background o f the
governmental u n it is s u in g bonds i s b a sic in the an
a l y s i s o f m unicipal s e c u r i t i e s .
Of n e c e s s ity the
scope o f t h is review i s q u ite broad. I t encompasses
such to p ic s as the n a tu ra l re so u rce s o f the a re a ,
pop ulation change, and in d u s tr ia l developm ent.
To
be o f maximum u se fu ln e s s i t i s n e ce ssary to cover
the p ast reco rd o f development as w e ll as the future
p ro sp e c ts . Sometimes i t i s easy to tr a c e the essen
t i a l fe a tu r e s o f the economic background in a n a ly z
in g m unicipal c r e d i t .
More fr e q u e n tly , however,
the a n a ly s t i s oonfourided by the mass and complex
i t y o f d e t a i l s . Up to now, most review s have tended
to be h i s t o r i c a l and s u b je c tiv e in c h a r a c te r .
Some e x c e lle n t economic s tu d ie s o f c e r ta in
geographic areas have been prepared by research
w orkers in s e v e r a l u n i v e r s i t i e s .! / In such s tu d ie s
the data have been s e le c te d w ith d isc rim in a tio n and
the r e s u lt s have been organized and expressed
c le a r ly in w e ll- w r itt e n r e p o r ts .
A m unicipal f i
nance o f f i c e r may o b ta in „guidance from such s tu d ie s
in a n a ly zin g the economic background o f h is a re a .
Moreover, he has an in tim ate knowledge o f h is own
Community, and w ith a l i t t l e guidance he can open
up a storehouse o f economic inform ation f o r use in
a n a ly t ic a l work.
The debt s tru c tu re o f an is s u e r p la y s an im
p o rtan t p a rt in answering the c e n tr a l question in
m unicipal s e c u r ity a n a ly s is .
Both the s iz e and
com position o f th e 'd e b t are s i g n i f i c a n t .
Of im
portance lik e w is e i s the trend in the amount o f
debt and the p ro sp ects f o r fu tu re change.
By i t
s e l f » flu c tu a tio n in the amount o f debt i s a n e u tra l
fa c t.
But i t may become s i g n if i c a n t when join ed
w ith o th ers in the a n a ly t ic a l p ro ce ss. During y e a rs
o f expan sion , a growing debt may be b e a ra b le . On
the oth er hand, in a period o f d is in te g r a tio n ,
tro u b le w i l l a r is e i f the shrinkage o f debt i s not
commensurate w ith the d e c lin e in economic s tr e n g th .
The m unicipal fin an ce o f f i c e r can h e lp the a n a ly s t
by assem bling the data on debt s tr u c tu re and p re
se n tin g t h is inform ation in i t s proper frame o f
r e fe r e n c e .
a Look at N a tc he z.
Its E c o n o m i c R e s o u r c e s , by Earl L.
Bailey, Bu si n e s s Aids Series No. 8, Bureáu o f Busi ne ss Re
search, Univ er si ty of Mississippi, University, Mississippi,
1 953 ; and The Delta Looks Forward, an Inventory of— Nat u.raj
and Human Re so urces, by Robert Banker Highsaw, Di re c t o r of
the Bureau of Public A d m i ni st ra ti on , Univ er si ty of M i s s i s
sippi, and R e se ar ch C o ns ul ta nt to the Delta Council, Delta
C o u n c i l , S t o n e v i l l e , M i s s i s s i p p i , 1949, are i l l u s t r a t i o n s
o f s t u d i e s c o v e r i n g s o u t h e r n c o m m u n i t i e s wh i c h have been
u s e f u l in the a n a l y s i s of m u n i c i p a l c r e d i t s .
A l s o see
Sc h o o l Pent in F l o r i d a , by Cl ement H Donovan, U n i v e r s i t y
of Fl orida, pu b l i s h e d by Credit Policy Comm ittee, F l o r id a
B a n k e r s A s so ci at io n, Orlando, Florida, 1952, for a p r e s e n
tation of, data regard ini) a class of securities.
6
-
in v
The re p o rt on the cu rren t fin a n c ia l operations
cre
o f an is s u e r i s a primary source o f inform ation for
m unicipal s e c u r ity a n a ly s is .
A ls o , t h is rep o rt is
ca^
o f major concern to the m unicipal fin an ce o f fic e r . /
Inform ation on the amount and com position o f incomeAJ^adv
and the p r in c ip a l item s o f expenditure i s furnished'TO C0U
by t h is r e p o r t.
I t s u se fu ln e ss in answering the f are
c e n tr a l question in s e c u r ity a n a ly s is depends upon
the q u a lity o f th e accounting which supports i t and
c o n s iste n c y in the manner o f i t s p rep aratio n .o ver a
period o f y e a r s . When the r e p o rts r e f l e c t good accounting p r a c t ic e s , an a n a ly s t has a b a s is fo r conp^e
fid e n c e in h is judgment.
On the other hand, shaky
0f
accounting or c a re le ss n e ss in re p o rtin g tends to
Qcc
weaken confidence even in s itu a tio n s which other- ^ a g
wis‘e may be s a t is f a c t o r y .
I eva
i pos
In studying the margin f o r f in a n c ia l protec- I
tio n o f debt s e r v ic e ,t h e c r u c ia l question in secur- i
i t y a n a ly s is i s brought to sharp fo c u s . Rephrased,
the question i s t h i s :
Has the o b lig o r covered the
ana
expenses o f op eration by a margin adequate to mainhac
ta in debt s e r v ic e even in p eriod s o f a d v e rs ity ?
f UpC
The work o f an a n a ly s t i s g r e a t ly sim p lified J the
when the f in a n c ia l re p o rts are designed to show in j
c le a r - c u t fash io n the p r in c ip a l elem ents to be con- J whi
sid ered in judging the margin o f debt s e r v ic e pro- , arc
t e c t io n .
In preparing th ese r e p o r ts , there is no , to
form ula o f u n iv e r s a l a p p l i c a b i l i t y .
Form depends j Thj
on the in d iv id u a l circum stances in each c a s e .
In m unicipal s e c u r ity a n a ly s is i t i s e ssen tia l j to
both to earmark the im portant f a c t s and to measure
ane
t h e ir s ig n ific a n c e in terms o f reco gn ized investthe
ment stan d ard s. For example, the general property
sti
ta x has long been r e lie d upon as
the p rin cip al alj
source o f income f o r m u n ic ip a lit ie s . Moreover, the
the
r a t io o f debt to a ssessed va lu e i s g e n e r a lly ac"^4. in*
cepted as an in d ic a to r o f debt burden f o r o b lig a -^ y . quj
tio n s supported by the g en eral taxin g power o f the • fj to
is s u e r — the s o - c a lle d f u l l f a i t h and c r e d it securi- $ sia
t i e s . The r a tio n a le o f t h is debt r a t io measure has
been w e ll- e s ta b lis h e d in the f in a n c ia l lite r a tu r e .
Comparison o f the r a t io in a given case w ith stand- i pa;
ard debt r a t io s f o r the area h elp s
to guide judg- hi*
ment as to the investm ent q u a lity o f
the obligation. vi«
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As i l l u s t r a t i v e o f the com p lication s in muni¿g,
c ip a l s e c u r ity a n a ly s is , however, i t should be ^ qu;
noted th a t sometimes the r a t i o o f debt to assessed | pr<
value i s an u n s a tis fa c to r y measure fo r judging the J
q u a lity o f a g en era l o b lig a tio n bond.
When the ,
o b lig o r r e l i e s on ly to a v e r y lim ite d e x te n t upon I
the g en era l p roperty ta x as a source o f income, the
debt r a t io measures nothing th a t i s important.
A ls o , th ere are in sta n ces o f a ssessed v a lu e s which
have become so thoroughly d is to r te d th a t any compu
ta tio n based upon them can o n ly be m islead in g.
To demonstrate the q u a lity o f an obligation '
supported by the g en era l c r e d it o f th e issu er,th ere
i s need f o r evidence th a t the lo c a l government has
a margin o f unused taxin g power supported by ade
quate economic re s o u r c e s.
When a n a ly s is indicates ¡,
th a t the debt burden measure i s not appropriate in
a given s i t u a t io n , then i t i s n ecessary to adopt ^
the broader approach in order to ap praise credit
q u a lit y . For m unicipal fin an ce o f f i c e r s , consider
a tio n s such as th ese emphasize the v e r s a t i l i t y or j
the a n a ly t ic a l p ro c e s s .
Turning now from the a n a ly s is o f g en era l °bli~ lij
g a tio n s to another catego ry o f m unicipal b o n d s ^
namely, those supported by a c t i v i t i e s o f a business ^
ty p e ,su ch as m u n icip a lly owned e l e c t r i c u t i l i t i e s - f o r th ese is su e s i t i s easy to fin d well-recognlz® a
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investment standards such as are used fo r judging
i c re d its in the f i e l d o f corporate s e c u r ity a n a ly s is .
To be su re, t h is standard i s not p r e c is e ly a p p licable because the u n it o f government conducting a c I t i v i t i e s o f a business type may en jo y c e rta in ta x
advantages.
But these fe a tu r e s are taken in to a c
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the process o f a n a ly s is and the r e s u lt s
are te s te d by the e s ta b lis h e d r u le s fo r judging e f f ic ie n t o p eratio n s and debt s e r v ic e co verage.
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By c o n tr a s t, when m unicipal s e c u r ity a n a ly s is
is ap plied to o b lig a tio n s whose c r e d it r e s t s on the
pledge o f income from a s p e c if ic ta x , the problem
of judging q u a lity i s l i k e l y to be q u ite stubborn.
O ccasionally th ese cases are fu r th e r com plicated by
a general pledge o f c r e d it th a t i s d i f f i c u l t to
evaluate. In some in sta n c e s i t seems v i r t u a l l y impossible to ap praise the margin o f p ro te ctio n fo r
the bondholders.
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In th is b r ie f sketch o f m unicipal s e c u r ity
a n a ly sis, the process o f s i f t i n g p e rtin e n t f a c t s
has been o u tlin e d and some s tr e s s has been placed
upon the s e le c t io n o f ap pro p riate investm ent stan dards fo r a p p ra isin g the d a ta .
Broad exp erien ce in
the f i e l d o f a n a ly s is fu rn ish e s the only b a s is f o r
c la s s ify in g o b lig a tio n s in to homogeneous groups fo r
which standards may be developed.
Before a standard i s a p p lied in a g iv en s i t u a t i o n , i t i s n ecessary
to a rr iv e a t a judgment as to i t s a p p ro p ria ten ess,
This judgment r e s t s alm ost s o le ly upon ex p e rie n ce.
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Many sh o rt cu ts have been suggested from time
time in order to s im p lify m unicipal s e c u r ity
a n a ly sis. O c ca sio n a lly th ese sh o rt cu ts have served
the purpose v e ry w e ll although th a t can be demonstrated only by the conventional procedure fo r an
a ly s is .
N e v e rth e le ss, th ere have been times when
the answers produced by the sh o rt cu ts were exceedt l y m islead in g.
As a m atter o f f a c t , easy and
quick answers in s e c u r ity a n a ly s is are not l i k e l y
to be good ones even though th ey would be very des ira b le .
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This concludes a v e ry b r ie f review o f m unici
pal s e c u r ity a n a ly s is which was designed m erely to
h igh lig h t the major p o in ts in the p ro ce ss. The r e vJ81w has served i t s purposes i f i t reminds the muDic*Pal fin an ce o f f i c e r th a t the a n a ly tic a l work
rests upon h is r e p o r ts . Good s e c u r ity a n a ly s is r e quires h is w holehearted cooperation as an e s s e n tia l
p re re q u isite .
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Summary and Conclusion
In summary, the c h ie f purpose o f t h is d is c u s
sion i s to ex p la in why m unicipal fin an ce o f f i c e r s
should concern them selves about bank
investm ent
problems and a n a ly t ic a l techniques fo r determ ining
the investm ent q u a lit ie s o f m unicipal s e c u r i t ie s .
There may be a tendency to overlook the importance
o f th ese c o n s id e ra tio n s.
F a cts are presented to show the r o le o f banks
as s u p p lie r s o f c r e d it to S ta te s and oth er u n its of
government and the p lace occupied by th e ir o b lig a
tio n s in the a s s e t | s tr u c tu re o f the
commercial
banks.
These banks now fu rn is h about o n e -th ird o f
the c r e d it extended to m u n ic ip a litie s through own
e rsh ip o f s e c u r i t ie s , whereas in 1937 t h is proportio p was on ly a l i t t l e more than 15$,
The amount
o f m unicipal o b lig a tio n s in bank p o r tfo lio s has in
creased from a l e v e l o f about $3 b i ll io n a t the end
o f World War I I to approxim ately #10 b i l l i o n . How
e v e r , the proportion o f bank a s s e ts in vested in
m unicipals now has returned to the 5% le v e l which
p re v a ile d over the pre-war y e a r s .
F ollow in g the development o f t h is fa c tu a l back
ground, the a tte n tio n o f the p u b lic fin an ce o f f i c e r
i s cen tered b r i e f l y on a few o f the b a sic principles
in managing a bank investm ent p o r t f o lio . S tr e s s i s
placed upon high q u a lity as a r e q u is ite fo r
bank
a sse ts.
In a d d itio n , a b r ie f comment i s made r e
gardin g the m atu rity schedule fo r bank investm ents
as an element in managing fun d s.
A ls o , some con
s id e r a tio n i s g iv e n to oth er f a c t o r s such as
the
d is tr ib u tio n o f r i s k s .
In order th a t m unicipal fin an ce o f f i c e r s may
have a b e tte r understanding o f the purposes served
by th e ir f in a n c ia l re p o rts in the bank investm ent
p ro cess, m unicipal s e c u r ity a n a ly s is techniques are
review ed b r i e f l y .
This review i s developed around
the b a s ic question which a n a ly s is seeks to answer,
namely:
W ill the f in a n c ia l o b lig a tio n under study
be paid according to i t s terms?
The m unicipal fin an ce o f f i c e r i s in a s t r a t e
g ic p o s itio n to f a c i l i t a t e the investm ent p ro ce ss.
With p rop erly designed r e p o r ts , he can h elp in v e s t
ment a n a ly s ts to have confidence in the con clu sion s
which they reach in the course o f th e ir work. This
i s on ly one o f the many f a c e t s o f f in a n c ia l manage
ment, but i t i s v i t a l n o n eth eless.
@FedFRASER