Site search Web search

MUNICIPAL BOND  

A municipal bond, or “muni,” is a debt obligation of a U.S. state or political subdivision (county, city, town, village or other authority), which is exempt from federal income taxes.  Usually a municipal security’s interest payments are exempt from state and local income taxes as well.  Being exempt from federal income taxation is a major strength of municipal bonds.  However, their interest yields are always lower than comparable taxable bonds (government and corporate) of equivalent rating and maturity.  There are $1.5 trillion bonds outstanding. 

Municipal bonds come in two primary categories: 

·      General Obligation Issues 

The first are general obligation notes and bonds that are backed by the full faith and credit (and taxing power) of the issuer.  Sometimes the issuer is additionally backed by federal and state aid. 

·      Specific Revenue Obligation Issues 

The second form is the revenue obligation municipal bond, which is used to finance specific projects such as bridges and sewer systems, and to repay the revenues from the facilities that are financed.  Examples are housing bonds, utility revenue bonds, hospital revenue bonds and industrial development bonds.  

Municipal bonds are normally issued in $5,000 minimum denominations, with each bond having a $1,000 par value.  Maturities vary from notes ranging from 90 days to 5 years, to bonds that typically have 5 to 30 year durations until maturity.  In the U.S. today over 100 different brokerage houses, banks, and other investment companies are underwriters for corporate, municipal and government bond issues. 

BOND RATING  

The rating of municipal bonds is similar to that of corporate bonds.  Municipals are rated by Standard and Poor’s, Moody’s, and Fitch Rating Services.  

In addition, municipal notes have another form of rating that addresses the concerns of the short-term bond market place.  Standard and Poor’s rate notes maturing in 3 years or less by rating them SP-1, SP-2, and SP-3.

This note rating system analyzes the amortization schedule of the short-term notes and the source of payment for interest and principal.  SP-1 reflects a strong capacity to pay interest and principal.  The SP-1+ rating reflects overwhelming safety characteristics.  SP-2 notes are considered to have satisfactory capacity to pay principal and interest.  SP-3 notes are deemed to have a speculative capacity to pay principal and interest.

Moody’s has a similar note rating system ranging from MIG-1 (highest) to MIG-4 (lowest).  

The municipal bond marketplace is huge, valued at 1.5 trillion as of 1999.  New long-term issues in 1999 totaled $226 billion.  It, too, is becoming a more sophisticated marketplace as was shown by the 1985 initiation of Municipal Bond Futures trading, which followed the introduction of trading in Treasury Bond futures.  Although municipal bonds are considered safe, they have had default problems.  

BOND INSURANCE  

There is additional confusion resulting from municipal bonds being insured by insurance companies.  Insuring municipal bonds has been a practice for over 15 years since AMBAC Indemnity Corporation began offering such insurance.  The practice is growing.  

In 1980, only 3% of all bonds issued were insured, compared to over 30% currently.  The cost of insurance for municipal bonds amounts to a reduced yield of about 0.5%.  AMBAC, who had insured Washington Public Power Systems Bonds (WPPS), is paying $23.5 million in claims resulting from the largest municipal bond failure in U.S. history.  With the bankruptcy of Orange County in 1994 due to losses incurred from derivatives, the WPPS failure may be surpassed.  

In recent years, the municipal bond marketplace has been hit by scandal and confusion.  A 1987 federal probe began looking into possible violations of insurance issuance requirements involving several underwriters and $12 million of municipal bonds.  Over 100 different municipal bond issues were involved.  Various class action lawsuits were filed.  The complaints involved allegations that projects had insufficient regional support to survive, had questionable tax status to permit exemption from taxes on interest payment, and that some of the issuers were unlicensed to market the bonds.  

When WPPS bonds were introduced, Moody’s and S&P assigned ratings of A+ and A-1.  By May 1981 several analysts forecast the nuclear power plants would never be completed.  Ratings declined only somewhat, and were still classified as “investment grade.”

INCOME TAX COMPLICATIONS  

Municipal bonds have also been in a state of confusion due to tax law revisions.  When federal tax brackets are at high levels municipal bonds are attractive because their exclusion of interest from being taxed provides a greater “after tax” yield for investors.

Municipal bonds are growing more popular with investors since tax laws passed in the 1990's raised brackets.  

In 2001, a taxpayer filing jointly with income of $105,951 is in the 31% federal bracket.  If state taxation is at 5%, a 6% municipal bond is equal to a 9.4% corporate bond yield after taxes are considered.  

Securities offered through Sigma Financial Corporation. A registered broker/dealer. Member FINRA & SIPC.

Send mail to Webmaster with questions or comments about this web site.
Copyright © 2007 R & D Financial Services Inc.
Last modified: 11/04/07