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How Safe Are Municipal Bonds?

When you invest in a municipal bond, your primary concern should be the issuer’s ability to meet its financial obligations. Issuers of municipal bonds have a record of meeting interest and principal payments in a timely manner. Issuers disclose details of their financial condition through “official statements” or “offering circulars,” which are available through the Municipal Securities Rulemaking Board's Electronic Municipal Market Access (EMMA) portal at http://emma.msrb.org. They may also be obtained from your bank, brokerage firm, or on the Internet. Issuers also provide continuing disclosure about their financial condition, now available on EMMA starting July 1, 2009. You may also contact the issuer or visit the issuer’s web site for updated or current information.

Another way to evaluate an issuer is to examine its credit rating. Many bonds are graded by ratings agencies such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. A number of banks and brokerage firms have their own municipal bond research departments. Bond ratings are important benchmarks because they reflect a professional assessment of the issuer’s ability to repay the bond’s face value at maturity.

Generally, bonds rated BBB (Standard & Poor’s and Fitch) or Baa better (Moody’s) are considered “Investment Grade,” suitable for preservation of investment capital.

In early April 2010, Fitch Ratings overhauled the way it assigns grades to the credit quality of state and local governments, recalibrating ratings on 40 states, the District of Columbia, the Virgin Islands and Puerto Rico. The move affects some 38,000 municipal bond issues. The rating agency's wholesale recalibration is in part recognition that municipalities were being held to a higher standard than corporate and sovereign debt. Moody's Investors Service also started to recalibrate its universe of municipal bond ratings in mid-April 2010, beginning with changes for 34 states and Puerto Rico.

Municipalities historically exhibit stronger repayment patterns than corporate borrowers in the same credit rating bracket. The municipal rating recalibrations are a way to align municipal bonds with debt from other sectors.

For Fitch, state and local general obligation (GO) ratings and those dependent on them (appropriation-backed debt) were adjusted upward two notches if the GO rating currently rated A to BBB; and one notch upward if the GO rated A-plus or higher. Special tax-backed bonds currently rated from BBB to AA-plus were adjusted up one notch. Water/sewer and public power distribution-only credits will be adjusted upward in the same manner as GO ratings. Public higher education ratings will be adjusted up one notch where the rating is currently AA to BBB; no adjustment was made on public higher education ratings of AA and higher. The ratings systems from other agencies listed below have not been adjusted.

 
Credit Ratings
Credit Risk Moody’s Standard & Poor’s Fitch
Strongest Aaa AAA AAA
Aa AA AA
A A A
Baa BBB BBB
Ba BB BB
B, Caa, Ca, C  B, CCC, CC, C B, CCC, CC, C
Weakest C D D

Credit ratings, however, should not be the sole basis for any investment decision. Before purchasing bonds talk with your investment advisor to make sure they’re suitable for you.

Tax-exempt municipal bonds offer you the chance to maximize your after-tax return consistent with the amount of risk you’re willing to accept. In general, as with any fixed-income investment, the higher the yield, the higher the risk.

 

All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.