Municipal Securities

Municipal Securities

Municipal securities are debt obligations, both bonds and notes, issued by states, territories (such as Puerto Rico), political subdivisions (such as counties and cities), special districts (schools, water works, sewer systems, etc) and public agencies such as authorities and commissions.

United States government securities are NOT municipal securities.

They are issued to obtain funds to build or repair facilites such as streets, bridges, water works, power generating facilities and schools, or to meet other needs of the municipality. As with other debt securities, the issuer agrees to pay interest semiannually and to repay the principal at maturity. Municipal securities are exempt from the filing provisions of the Securities Act of 1933 and are therefore not registered with the SEC.

Tax Exemption

The interest received on municipal bonds is exempt from Federal income tax, however, the interest may be subject to state and local taxes. (the opposite is true with respect to US government securities, where the interest is exempt from state and local income taxes, but is subject to Federal income tax).

This means the Federal Government cannot tax local government, and the local government cannot tax the Federal government. This principal of reciprocal immunity from taxation stems from the dual levels of government in the United States and, while not in the constitution, has been upheld by the Supreme Court several times.

Most states will exempt the interest on bonds issued by political entities within their state, thus making these bonds "triple tax exempt" for residents of that state. For example, if a California resident purchases municipal bonds issued in California, the interest is exempt from Federal, state and local income taxes. If the same investor purchases the bonds issued in another state, such as NY, he or she is liable for California state and local income taxes on the interest.

Bonds issued by a commonwealth, territory or possession of the United States, such as the Commonwealth of Puerto Rico, US Virgin Islands or Guam are not subject to federal, state or local income taxes. They are therefore "triple tax exempt".

Please note that although interest on municipal securities is exempt from federal tax, and may be exempt from state and local taxes, any capital gain resulting from sale or redemption is subject to applicable taxes at the federal, state and local levels.

Maturities and Interest

Like other bonds previously discussed, municipal bonds have either short term or serial maturities.

Term Bonds - The entire issue matures at the same time. These are often used on projects with uncertain revenues, because none of the bonds are short term.

Serial Bonds - The issue matures over a period of several years. Serial maturities are often used for projects with a steady income stream. Serial bonds are quoted based on their yield to maturity. This is also called a basis quote.

 Serial Bonds with balloon maturities-are those where the largest number of bonds mature in a single year, known as the balloon year.

 The coupon rate, nominal rate, or stated interest rate, is shown on the face of a bond certificate as a percentage of par value. Par value for municipal bonds is $1,000.00. Interest on municipal bonds is paid semiannually, and payable dates are shown on the certificate. The maturity date (the date on which the principal must be repaid) is also stated on the face of the bond.

 Bonds in default trade without accrued interest, and are said to be "trading flat". Other bonds include: zeroes, and income or adjustment bonds, which pay interest only if earned.