StateTrust's trading desk unit actively executes trades and takes client orders in the Municipal Bond markets. Our traders have extensive experience in dealing with municipal securities and are readily available to help clients meet their investment objectives.
What are Municipal Bonds?
Municipal bonds, or Munis for short, are bonds issued by city, county, or state governments for a variety of projects such as building schools, expanding highways, or constructing a new sewage system. Municipal bonds may be general obligations of the issuer or secured by specified revenues. Interest income received by holders of municipal bonds is often exempt from federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.
The principal characteristics of Municipal Bonds are:
- Interest Payments - Usually, interest on a long-term municipal bond is paid semi-annually, while interest on short-term notes is paid at maturity.
- Form of issuance - Municipal bonds are issued in registered form only.
- Minimum investment - Most municipal notes and bonds are issued in minimum denominations of $5,000 or multiples of $5,000.
- Reporting requirements - All tax-exempt interest must be reported on tax returns. This is simply a reporting requirement and does not affect the tax-exempt status of the security.
Please note: Investments in State and Municipal bonds are subject to political, economic and taxation risks.
Types of Municipal Bonds
The following Table lists mayor types of Municipal Bonds:
| Muni Type | Description |
|---|---|
| General Obligation Bonds (GO Bonds) | Represent the largest group of municipal issues. Paid back by general revenues - secured by the government's tax revenue and its ability to impose new taxes - these bonds are only slightly less secure than similar government issues. By law, the government is required to levy taxes in order to pay its bondholders. |
| Revenue Bonds | Used in the development of toll roads, bridges, or tunnels, or any revenue-producing projects, these bonds are paid off by the revenues generated from the specific development. They typically offer a higher rate of interest than GO Bonds, as payment is more narrowly backed. |
| Industrial Development Bonds | Issued by state and local governments to fund the construction of new industrial parks or plants, or any development that might attract businesses and increase leasing revenue for the state. The financial strength of the private businesses involved in the project generally determines the quality of the bond. Most are now taxable under the Tax Reform Act of 1986. |
| Redevelopment Agency Bonds | Used for the construction of commercial projects, these bonds are secured by part of the property taxes levied on the development. |
| Airport Bonds | Bonds used toward securing general operations of airports agencies. Another riskier bond is tied specifically to facilities leased by individual airlines and is secured by the leasing contract itself. |
Taxability of Municipal Bonds
One of the primary reasons municipal bonds are considered separately from other types of bonds is their special ability to provide tax-exempt income. Interest paid by the issuer to bond holders is often exempt from all federal taxes, as well as state or local taxes depending on the state in which the issuer is located, subject to certain restrictions. Bonds issued for certain purposes are subject to the alternative minimum tax.
The type of project or projects that are funded by a bond affects the taxability of income received on the bonds held by bond holders. Interest earnings on bonds that fund projects that are used for the public good are generally exempt from federal income tax, while interest earnings on bonds issued to fund projects partly or wholly benefiting only private parties, sometimes referred to as private activity bonds, may be subject to federal income tax. However, qualified private activity bonds, whether issued by a governmental unit or private entity, are exempt from federal taxes because the bonds are financing services or facilities that, while meeting the private activity tests, are needed by a government.
The laws governing the taxability of municipal bond income are complex; however, bonds are typically certified by a law firm as either tax-exempt (federal and/or state income tax) or taxable before they are offered to the market. Purchasers of municipal bonds should be aware that not all municipal bonds are tax-exempt.
Comparison to Corporate Bonds and Other Taxable Securities
Because municipal bonds are most often tax-exempt, comparing the coupon rates of municipal bonds to corporate or other taxable bonds can be misleading. Taxes reduce the net income on taxable bonds, meaning that a tax-exempt municipal bond has a higher after-tax yield than a corporate bond with the same coupon rate.
This relationship can be demonstrated mathematically, as follows:
| Interest_RateM = Interest_RateC * ( 1.0 - Tax_Rate )
6% = 9% * (1.0 - 0.33) |
|
| Where: | Interest_RateM = Interest Rate of a Municipal Bond |
| Interest_RateC = Interest Rate of a Corporate Bond | |
For example, if a corporate bond has a coupon of 9% and the tax rate for the individual buying that bond is 33%, then the individual would receive an after tax yield of 6%. If the municipal bond has an after tax yield of 6%, then the after tax yields of both bonds would be equivalent.
Default Rates - Municipal Bonds vs Corporate Bonds
The historical default rate for municipal bonds is lower than that of corporate bonds. The Municipal Bond Fairness Act (HR 6308), introduced on September 9, 2008, included the following table giving bond default rates up to 2007 for municipal versus corporate bonds by rating and rating agency.
| Rating Category | Moody's | S & P | ||
| Muni | Corporate | Muni | Corporate | |
| Aaa / AAA | 0.00 % | 0.52 % | 0.00 % | 0.60 % |
| Aa / AA | 0.06 | 0.52 | 0.00 | 1.50 |
| A / A | 0.03 | 1.29 | 0.23 | 2.91 |
| Baa / BBB | 0.13 | 4.64 | 0.32 | 10.29 |
| Ba / BB | 2.65 | 19.12 | 1.74 | 29.93 |
| B / B | 11.86 | 43.34 | 8.48 | 53.72 |
| Caa / CCC-C | 16.58 | 69.18 | 44.81 | 69.19 |
| Investment Grade | 0.07 | 2.09 | 0.20 | 4.14 |
| Non Investment Grade | 4.29 | 31.37 | 7.37 | 42.35 |
| All | 0.10 | 9.70 | 0.29 | 12.98 |