Municipal bonds are great investment tools, especially if an investor can take advantage of their tax benefits. However, as with any investment, municipal bonds come with their own set of risks.
Investors should be familiar with what makes a muni bond safe in order to successfully avoid losing their investments to declarations of bankruptcy. Remember that unusually high yields may often be coupled with poor credit ratings or even “junk” status which may indicate future financial troubles for the issuing municipality.
In this article, we’ll explore what makes a safe municipal bond, how to track that safety, and then wrap up with the 10 safest municipal bonds for 2015.
A Brief Primer on Muni Bonds
Municipal bonds, or muni bonds for short, are issued by states, counties, cities, or other agencies to finance public projects such as schools, roads, bridges, utilities, housing, airports, hospitals and other facilities. These bonds can be long-term fixed rate bonds, short-term notes, variable-rate securities, zero-coupon bonds, taxable securities or other types of securities. The vast majority of these bonds are held until maturity by individual investors via funds.
Since they are backed by government agencies, muni bonds are generally considered to be very safe, with less than 0.5% of outstanding muni bonds falling into default in any given year. These figures are especially impressive considering that there are more than one million bonds outstanding, representing some $3.7 trillion in principal value, according to a report by the U.S. Securities and Exchange Commission (SEC) in July of 2012.
Finding Safety in Muni Bonds
Investors researching muni bonds can find most of the information they need on the Municipal Securities Rule-Making Board’s Electronic Municipal Market Access or EMMA platform. After inputting a muni bond’s CUSIP or name, investors can access information about the interest rate, payment timing, redeeming attributes, default consequences, financial/operational information, and various other important pieces of information.
Here are some key pieces of advice to keep in mind when researching:
- Size Sometimes Matters. Muni bonds issued by larger municipalities aren’t necessarily more financially sound, but they are likely to be easier to sell with more liquidity. In general, investors should pursue municipalities with a population of over 10,000.
- Choosing the Right Type. There are many different types of muni bonds, including revenue bonds and general obligation bonds. Most of the time, general obligation bonds are considered the safer investment, although they often pay a lower yield.
- Watch Credit Ratings. Muni bond credit ratings are extremely important to the lay investor, as these ratings take into account things like debt service coverage ratios. Most investors should seek out debt service coverage ratios above 2.0x and AAA-rated bonds.
- Look for Insurance. Approximately half of all muni bonds are covered by large insurance companies, which guarantee payments and provide an AAA rating. In general, investors should seek out top-rated muni bonds or those insured to have the top rating.
- Common Sense. Municipalities that have thriving downtowns, growing populations, and improving economics represent the safest investments, while investors should avoid those moving in the opposite direction like Detroit.
- Be Wary of Certain Bonds. Build America, structured or appropriation bonds can be riskier, since some of them are subject to change and/or may not be backed by a sound issuer or substantial revenue source needed to ensure security.
Keeping Track of Muni Bonds
Municipal bond holders should be concerned with two things: changing technical aspects of the bonds and the underlying health of the municipality. The first of these elements can be tracked using the EMMA platform’s “continuing disclosures,” which supports automatic e-mail alerts designed to keep investors up to date. The second item requires a bit more legwork on the part of the investor to ensure the safety of their investment over time.
Continuing disclosures contain information about the financial or operating condition of the issuer as it changes over time and specific events that could impact the bond’s valuation or its ability to make payments. Mandatory disclosures are made under contractual agreements entered into under Rule 15c2-12 of the Securities and Exchange Act of 1934, while voluntary disclosures are made without any contractual obligations to do so.
Ratings agencies like Standard & Poor’s, Moody’s, and Fitch provide the most accessible information about the underlying health of municipalities via their bond ratings. Investors can find these ratings on any number of websites or some online brokers. Additional information about the health of a municipality can be found in that municipality’s public records, which are often available online or at the relevant clerk’s office.
Top 10 Safest Municipal Bonds
- Williamson County Texas Unlimited Road Tax Road Bonds Series 2007 (969887UH9): These Texan AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 4.75% interest rate and long-term February 15, 2032 maturity date.
- Lamar, Texas Consolidated Independent School District Unlimited Tax Schoolhouse and Refunding Bonds Series 2015 (513174UV2): These Texan AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 4% interest rate and long-term February 15, 2045 maturity date.
- Harrison County Flood Control Improvement Bonds Series 2007 (4140182L4): These Texan AAA-rated, insured, general obligation bonds are backed by limited taxation, with a 5% interest rate and long-term October 1, 2031 maturity date.
- Baltimore County Maryland Metropolitan District 70th Issue 2006 (0591325G1): These Maryland AAA-rated bonds are guaranteed by the pledge of the full faith and credit and unlimited taxing power of the county. They are general obligation bonds backed by unlimited taxation, with a 4% interest rate and short-term September 1, 2018 maturity date.
- City of Virginia Beach Virginia GO Public Improvement Bonds Series 2005 (927734QW6): These Virginian AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 5% interest rate and medium-term January 15, 2021 maturity.
- City of Minneapolis Minnesota GO Improvement Bonds Series 2002 (60374A5Q8): These Minnesota AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 5.25% interest rate and December 1, 2026 maturity date.
- Polk County Iowa GO Bond Series 2006B (731197TP4): These Iowa AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 4.1% interest rate and near-term June 1, 2017 maturity date.
- Byram Hills New York Central School District Serial Bonds 2005 (124439GL8): These New York AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 4% interest rate and medium-term December 15, 2019 maturity.
- State of Tennessee GO Bonds 2003 Series A (880541CE5): These Tennessee AAA-rated, insured, general obligation bonds are backed by unlimited taxation, with a 5% interest rate and short-term August 1, 2018 maturity date.
- Oklahoma City Oklahoma GO Refunding Bonds Series 2005 (678519FD6): These Oklahoma AAA-rated, insured, general obligation bonds are backed by taxation, with a 5% interest rate and short-term September 1, 2018 maturity date.
The Bottom Line
Investing in municipal bonds can be risky, but investors can avoid a lot of this risk by seeking out AAA-rated general obligation bonds located in states and cities with strong economies. While these muni bonds may not offer the same yields as riskier municipalities or bond types, income investors looking for a safe return can be reasonably certain of the interest and principal.