AAA rated muni bonds have a default rate of less than 0.1%.
Investing in AAA rated muni bonds can provide a stable source of income for your retirement.
These bonds are issued by municipalities and are backed by the credit of the issuing entity, which is typically strong.
AAA rated muni bonds have a high credit rating, indicating a very low risk of default.
The tax-exempt status of muni bonds can also provide a significant advantage for investors in higher tax brackets.
Investors can earn a regular income stream from the interest payments on these bonds.
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Municipal Bond Ratings
Municipal bond ratings play a critical role in determining the interest rate on issued debt. They give investors information about the likelihood of bonds defaulting. The Municipal bond ratings on projects backed by essential services like water, power, and sewage are generally very high and carry the smallest degree of investment risk.
Investors 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.
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Muni bonds issued by larger municipalities aren't necessarily more financially sound, but they are likely to be easier to sell with more liquidity. Investors should pursue municipalities with a population of over 10,000. The following table summarizes the importance of municipal bond ratings:
Supply easing, demand strengthening
The municipal bond market is well positioned to begin the fourth quarter, thanks to a significant increase in supply during the second and third quarters. This surge in supply was driven by issuers bringing deals that had been long delayed due to execution uncertainty and seeking to get ahead of potential volatility around the U.S. election.
Deals have been routinely oversubscribed, indicating insatiable demand that points to improved performance potential once supply likely tapers after the election. In fact, investor fund flows stemming from cash on the sidelines may see continued strength, as T-bills originally purchased in the 5% range are quickly rolling off.
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Yields remain historically elevated, at nearly 100 basis points (bps) above the trailing 10-year average. This presents an attractive opportunity for investors to enjoy attractive total returns from income alone, a dynamic that has been absent for nearly a decade.
The yield curve should steepen more meaningfully as the Fed continues to cut rates, which should be positive for longer-duration bonds. In addition, the use of leverage through tender option bond trusts within portfolios is transitioning from a headwind to a tailwind as the municipal curve steepens.
Here's a breakdown of the changes in municipal-to-Treasury yield ratios over the quarter:
Municipal fund inflows strengthened during the quarter, reaching $10 billion (as of 18 Sep). This brings the year-to-date total to $21.3 billion.
Municipal Bond Ratings
Municipal bond ratings play a critical role in determining how much interest companies and other entities have to pay on their issued debt. They give investors information about the likelihood of bonds defaulting.
Municipal bond ratings are assigned by three major rating agencies: Moody's, Standard & Poor's, and Fitch. Each rating agency has a proprietary methodology for assigning ratings to a municipality.
High credit ratings allow the City to issue debt at lower borrowing costs. Moody's “Aaa” classification indicates that the City presents minimal credit risk. Standard & Poor's "AAA" classification is the highest rating in its system.
Investors can find municipal bond ratings on any number of websites or some online brokers. 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.
The Municipal Securities Rule-Making Board’s Electronic Municipal Market Access or EMMA platform provides investors with information about the interest rate, payment timing, redeeming attributes, default consequences, financial/operational information, and various other important pieces of information about a muni bond.
Here are some key pieces of advice to keep in mind when researching municipal bonds:
- 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.
- 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.
- Look for Insurance: Approximately half of all muni bonds are covered by large insurance companies, which guarantee payments and provide an AAA 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.
- 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.
Investors 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.
Understanding Ratings
Municipal bond ratings play a critical role in determining the interest rates on issued debt, giving investors information about the likelihood of bonds defaulting.
Investors who want to reduce risk and pay relatively low interest should consider projects with consistent, safe track records, such as those backed by essential services like water, power, and sewage.
The risk associated with corporate grade bonds is considerably higher than that of first-class municipal bonds, with Moody's municipal bond ratings scale showing much less common defaults and more successful recoveries.
Moody's, Standard & Poor's, and Fitch are the three major municipal bond rating agencies, each with their own proprietary methodology for assigning ratings to a municipality.
High credit ratings, such as Moody's “Aaa” or Standard & Poor's “AAA”, indicate minimal credit risk and allow cities to issue debt at lower borrowing costs.
Investors can avoid a lot of risk by seeking out AAA-rated general obligation bonds located in states and cities with strong economies.
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Investing in Municipal Bonds
Investing in municipal bonds can be a safe and rewarding experience, especially when it comes to AAA-rated muni bonds. These bonds are issued by states, counties, cities, or other agencies to finance public projects, and they are generally considered to be very safe, with less than 0.5% of outstanding muni bonds falling into default in any given year.
Municipal bonds are backed by government agencies, making them a more stable investment option compared to corporate bonds. In fact, Moody's municipal bond ratings scale shows that municipal bond rating defaults have been much less common, and recoveries in the event of default have been much more successful. This makes them an attractive option for investors looking to reduce risk and pay relatively low interest.
There are many different types of muni bonds, including revenue bonds and general obligation bonds. Most investors should seek out general obligation bonds, which are considered the safer investment, although they often pay a lower yield. A good starting point for research is the Municipal Securities Rule-Making Board's Electronic Municipal Market Access (EMMA) platform, where you can find information on interest rates, payment timing, and default consequences.
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Here are some key pieces of advice to keep in mind when researching muni bonds:
- 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.
- Choosing the Right Type: General obligation bonds are generally considered safer investments, but 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.
- Look for Insurance: Approximately half of all muni bonds are covered by large insurance companies, which guarantee payments and provide an AAA rating.
Window to Reinvest Cash is Short
The window to reinvest cash is short. You need to act quickly when you have the opportunity to reinvest your cash, as the market can change rapidly.
Investment grade municipal credit spreads were relatively unchanged in the third quarter, but income and changes in AAA benchmark yields were the main drivers of returns. This means you need to focus on the yields and income potential of the bonds you're considering.
The Bloomberg Municipal Bond Index returned 2.71% in the third quarter, while the Bloomberg U.S. Treasury Bond Index returned 4.74%. This shows that municipal bonds can be a good option for investors looking for lower returns, but still want to earn a decent income.
High yield municipal credit spreads tightened by 1 bps to end the quarter at 198 bps. This is a good sign for investors, as it means they can earn a higher return on their investments.
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Here are some key points to keep in mind when considering high yield municipal bonds:
- High yield technicals should improve further as fund flows pick up.
- This should be a catalyst for further spread tightening, particularly in more alpha-driven exposure where credit selection and research drive price appreciation.
The ability to source these deals compared to more beta-driven exposure in the larger areas of the high yield market provides meaningful credit spread compression opportunity. This means you can earn a higher return on your investments if you're willing to do your research and select the right bonds.
Bond Management
Bond Management is a crucial aspect of investing in municipal bonds. You should be concerned with two things: changing technical aspects of the bonds and the underlying health of the municipality.
To keep track of the technical aspects, use the EMMA platform's "continuing disclosures", which sends automatic email alerts to keep you informed. These disclosures contain information about the municipality's financial or operating condition and events that could impact the bond's value.
Ratings agencies like Standard & Poor's, Moody's, and Fitch provide information about the municipality's health through their bond ratings, which are easily accessible online or through some online brokers. Ratings can give you an idea of a municipality's creditworthiness.
Investors can also find additional information about a municipality's health in its public records, which are often available online or at the relevant clerk's office. Public records can provide a more in-depth look at a municipality's financial situation.
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Why Municipal Bond Funds Now?
Municipal bond funds are looking attractive right now, especially with the current municipal yield curve being inverted. This means shorter-maturity yields are higher than longer-maturity yields, which is a rare occurrence.
The last time this happened, the inversion lasted only a week, but this time the window may be open a bit longer due to economic uncertainty. However, it's essential to remember the strong credit quality that municipals have demonstrated over the years.
Municipal-to-corporate bond yield ratios are at extremes, which can lead to higher returns for high-quality municipal bonds. In the last seven years, when this ratio has exceeded its long-term average, high-quality municipal bonds have enjoyed total returns of 5-10%.
The U.S. government is providing unprecedented stimulus, injecting approximately $2 trillion toward essential services like hospitals and transportation. This should benefit certain municipal bonds.
The Federal Reserve Bank is also providing unprecedented liquidity, with $700 billion in loans via its Money Market Lending Facility, and unlimited quantitative easing. This should help all corners of financial markets, including municipals.
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Here are four key points to consider while contemplating an allocation of sidelined cash to municipal bonds:
- Yieldcurve: Currently the municipal yield curve is inverted, with the Securities Industry and Financial Markets Association (SIFMA) tax-exempt seven-day rate at +5.2% as of March 20, 2020.
- Municipal-to-corporate bond yield ratios are at extremes.
- Government providing unprecedented stimulus.
- Federal Reserve Bank is providing unprecedented liquidity.
These factors combined create a compelling case for investing in municipal bond funds now.
Top Municipal Bonds and Funds
Municipal bonds are considered some of the safest investments out there, with less than 0.5% of outstanding muni bonds falling into default in any given year.
The vast majority of these bonds are held until maturity by individual investors via funds, and are backed by government agencies.
Some of the safest municipal bonds include the Williamson County Texas Unlimited Road Tax Road Bonds Series 2007, which has a 4.75% interest rate and a long-term maturity date of February 15, 2032.
The Lamar, Texas Consolidated Independent School District Unlimited Tax Schoolhouse and Refunding Bonds Series 2015 also stands out, with a 4% interest rate and a long-term maturity date of February 15, 2045.
Other notable mentions include the City of Virginia Beach Virginia GO Public Improvement Bonds Series 2005, which has a 5% interest rate and a medium-term maturity date of January 15, 2021.
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Here are some of the top municipal bonds and funds:
These bonds are all AAA-rated, insured, and backed by unlimited taxation, making them some of the safest investments out there.
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