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Municipal Bond Checklist

Municipal Bond Checklist, featured by top securities fraud attorneys, the White Law Group

Investing in Municipal Bonds

People typically invest in municipal bonds because of the tax benefits they offer, and the fact that they’re generally known for being, “low risk investments”.  While municipal bonds (or muni’s) are generally a conservative, safer option than investing in stocks or junk bonds, investing in municipal bonds is not without their own risks.

What are Municipal Bonds?

Municipal bonds are a type of debt security issued by state and local governments. They are used to finance public projects such as schools, roads, and hospitals. These unique bonds allow individuals to lend money to state and local governments. In return, the governments pay interest on the borrowed funds. The tax benefits of municipal bonds are an attractive quality because the interest income earned is generally exempt from federal income tax. Additionally, if the investor lives in the state where the bond was issued, the interest income may also be exempt from the state and local taxes.

What are the Risks of Municipal Bonds? 

Changes in Interest Rates: These changes can impact the value of municipal bonds in a few ways. If interest rates rise, the value of existing bonds may decrease because investors can earn a higher rate of return on new bonds with higher interest rates. If the rates fall, the value of existing bonds may increase because investors are willing to pay a higher price for bonds with those higher rates.

Called or Redeemed Early: When a bond is called or redeemed early, the investor may receive less than the face value of the bond. This can happen if interest rates fall and the issuer decides to refinance the bond at a lower interest rate. To avoid this, some investors choose to invest in bonds with longer maturities, which are less likely to be called early.

Creditworthiness: The creditworthiness of the issuer is very important. If the issuer’s credit rating is downgraded, it could impact the value of the bond. This is because a lower credit rating could indicate a higher risk of default. Investors may demand a higher yield to compensate for this increased risk, which could then lower the price of the bond.

 Muni Bonds Gone Bad

In 2015 The Financial Industry Regulatory Authority (FINRA) announced that it has censured and fined UBS Financial Services Incorporated of Puerto Rico (UBS PR) $7.5 million for supervisory failures related to the suitability of transactions in Puerto Rican closed-end fund (CEF) shares. In addition, FINRA ordered UBS PR to pay approximately $11 million in restitution to 165 customers who were forced to realize losses on their CEF positions.

Further, in May of 2017Puerto Rico and its federal financial oversight board got hit with an onslaught of lawsuits from COFINA bond holders, GO bondholders and bond insurer Ambac Assurance Corp. COFINA bondholders allege that the island’s debt-cutting plans violate the U.S. Constitution. The GO bondholders are demanding payment on $242.5 million of debt defaulted upon since July, and damages and interest of more than $102 million.

According to Bloomberg News, in February of 2019, the Vanguard Group held about $415 million of municipal bonds issued on behalf of PG&E Corp., about half of the $920 million state and local debt sold for the California utility that filed for bankruptcy because of the devastating California wildfires. Some tax-exempt bonds PG&E issued through state and local conduits slid during pre- bankruptcy discussions, raising the risk that even debt that was issued through government agencies may not be paid back in full.

In January of 2017, according to Morningstar, U.S. mutual funds currently hold nearly $1 billion in US Virgin Islands bonds. The US Virgin Islands has high levels of debt, mounting pension obligations and a decreasing population. The US Virgin Islands’ overall tax-supported debt at $2 billion is much lower than Puerto Rico’s $53 billion in tax-supported debt, however per capita debt is about a third higher: $19,000 in the USVI compared with $12,000 for Puerto Rico, according an article in Forbes.

How Can you Avoid These Risks?

FINRA has created the following checklist to help investors avoid some of the most common pitfalls of municipal bond investing.

  • Verify the type of bond (general obligation vs. revenue), and make sure you understand the bond’s terms and risk factors (not all municipal bonds are created equal).

  •  Ask to see and read or have your financial advisor review with you—the bond’s Official Statement before you purchase a bond, particularly if it is a new issue. The Official Statement will be a valuable tool for understanding the terms of any bond you might buy in the secondary market, but be aware that the financial and operating data may have been superseded by the issuer’s on-going disclosures;

  •  Confirm with your financial advisor whether the issuer is current in its disclosure filings and be sure to review the information in the on-going disclosures (Be wary of bonds whose issuers are not current in their disclosure filings as this may be evidence that the bond is susceptible to default);

  • Keep tabs on your bond’s credit rating and the issuer’s creditworthiness. For example, has the issuer of the bond recently been downgraded? Has the issuer filed any default or other material event notices? Changes in the bond’s credit rating or the issuer’s creditworthiness may be evidence that the bond is susceptible to default;

  •  If the bond is insured or otherwise backed by a third-party, verify the credit rating of the bond insurer or other backing;

  • If you buy a bond in the secondary market, be sure to ask why the bond is priced as it is. Be aware that the price of a bond can be priced above or below its par value for many reasons, including changes in the creditworthiness of a bond’s issuer and a host of other factors, including prevailing interest rates (i.e. lower rated bonds are usually purchased at a discount for a reason);

  • Understand how the bond’s interest will be paid. Most muni bonds pay semiannually, but zero coupon municipal bonds pay all interest at the time the bond matures and the principal is returned. Variable rate bonds typically will pay interest more frequently, usually on a monthly basis in variable amounts. These are considerations if the financial advisor has advised you to purchase a municipal bond to provide current income because you will want to make sure that the interest is paid when you need the cash;

  • Understand the municipal bond’s tax implications, including the possibility that your bond may be subject to the federal Alternative Minimum Tax (AMT) or may be fully taxable. Also understand whether the bond enjoys any state tax benefits. Consider consulting a tax professional before buying a municipal bond because its tax implications may affect whether the bond is suitable for you;

  • Know a bond’s call provisions. Call provisions allow the issuer to retire the bond before it matures. You can find the call provisions in the Official Statement;

  •  Know what you are paying for your bond, which will be reported on your confirmation statement. Most bonds are sold without a commission (instead, the broker usually is compensated through a dealer’s spread, or profit, which is included within the price). If a commission is charged, this will also be reported on your confirmation statement. As always, you will want to make sure that the financial advisor’s motivation in recommending the municipal bond is not the commission that he/she is deriving from the purchase;

  • Review your confirmation statement after the purchase of the municipal bond to be sure the information is accurate and in line with what you were told by your financial and what was contained in the Official Statement.

If you are concerned that you have been the victim of securities fraud related to municipal bonds or some other investment vehicle, The White Law Group we may be able to help. To speak to a securities attorney, please call The White Law Group at 888-637-5510.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Seattle, Washington.

For more information on The White Law Group and FINRA arbitration, please visit our website at https://whitesecuritieslaw.com/

Tags: Last modified: August 14, 2023