Municipal bonds

Taxability

The interest income on municipal bonds is generally exempt from federal taxes and from state taxes in the state of issuance.

Interest on certain private activity bonds may be subject to the Alternative Minimum Tax (AMT).

Interest on certain municipal bonds is subject to federal taxes. Some taxable municipals were issued to fund projects that, by federal government standards, don't provide a clear public benefit.

Build America Bonds are taxable municipal bonds that were issued in 2009 and 2010 to create and repair infrastructure, and provide a subsidy to issuers from the federal government of 35% on their interest costs.

Municipal bonds, when purchased at a discount, may subject investors to capital gains taxes when sold or redeemed. Investors should consult a tax professional for additional information.

Credit rating

Many municipal bonds are rated by agencies such as Moody's Investors Service and Standard & Poor's Corporation. Ratings reflect the agencies' assessment of the creditworthiness of the issuer and its ability to timely pay interest and repay principal.

Moody's and S&P focus on an issuer's financial condition and credit history.

• On the Moody’s rating scale, issues rated Baa3 or above are generally considered to be investment-grade, while those rated lower than Baa3 are generally considered to be below investment-grade.
• On the S&P rating scale, issues rated BBB– or above are generally considered to be investment-grade, while those rated lower than BBB– are generally considered to be below investment-grade.

Bonds rated below investment-grade are generally considered to carry a greater degree of risk than more highly rated bonds.

Disclosures

Issuers disclose information about bond issues and details of their financial condition in Official Statements, which are available through the Municipal Securities Rulemaking Board's Electronic Municipal Market Access (EMMA) portal. Issuers also provide continuing financial disclosures on EMMA.

Types

General obligation bonds offer principal and interest secured by the full faith and credit of the issuer and usually supported by the issuer’s taxing power.

Revenue bonds have principal and interest secured by particular streams of revenue such as tolls, charges, or rents paid by users of the facility built with bond proceeds. Revenue bonds are not backed by the full faith and credit of the issuer.

Insured bonds are backed by a guarantee from a municipal bond insurer. If an issuer defaults on payments, the insurer promises to make timely payments of interest and principal when due—subject to the ability of the insurer to pay claims. Before buying an insured municipal bond, consider the credit rating of both the insurer and the underlying issuer.

Liquidity

Vanguard Brokerage Services® doesn't make a market in municipal bonds. If you want to sell your municipal bonds prior to maturity, Vanguard Brokerage can provide access to an active secondary over-the-counter market for many municipal bonds. Liquidity will vary depending on a bond’s features, rating, or credit quality, lot size, and other market conditions.

Fees

On new issue municipals purchased in the primary market, Vanguard Brokerage may receive a concession from the issuer. If a concession isn't available, Vanguard Brokerage reserves the right to charge a commission. Commissions will be charged for transactions in the secondary market.

Risks

Municipal bond prices can rise or fall depending on interest rates. Interest rate changes generally have a greater effect on long-term bond prices.

All municipal bonds carry credit risk that the issuer will default or be unable to make timely payments of interest and principal.  Generally, lower-rated bonds carry more credit risk. 

Some municipal bonds have call provisions that allow the issuer to redeem the bonds prior to the stated maturity date.  Issuers typically call bonds during periods of declining interest rates. 

Some municipal bonds have sinking fund provisions, which require the issuer to periodically retire a predetermined number of bonds. 

Certain municipal bonds, including housing bonds and certificates of participation, may be callable at any time at the issuer’s discretion, despite specific stated call dates.  This provision is noted in the security description as “extraordinary calls” or “subject to extraordinary redemption.” 

Certain events can impact a municipal issuer’s financial situation and ability to make timely payments to bondholders, including economic, political, legal, or regulatory changes and natural disasters.  Event risk is unpredictable and can significantly impact bondholders. 

Municipal bonds sold prior to maturity may be subject to substantial gain or loss. The secondary market may also be limited.

Tobacco Settlement Bonds are typically backed solely by the issuing municipality's receipt of funds from the 1998 Master Settlements Agreement (MSA). The amount of Pledged Tobacco Receipts received is dependent on many factors, including future domestic cigarette consumption, the financial capability of the product manufacturers, and litigation affecting the MSA. Payments by the PMs under the MSA are subject to certain adjustments, some of which may be material. Overall risks of Tobacco bonds, among others, can include: structural risk, corporate credit risk, cash flow risk, and litigation risk. Consult the Official Statement for additional information. Tobacco bonds all have a Turbo Redemption provision. Turbo Redemption represents the requirement contained in the Indenture to apply 100% of all collections in excess of Indenture requirements to the special mandatory redemption of the Turbo Term Bonds at their principal amount or Accreted Value on each Distribution Date, in accordance with the Payment Priorities. This means that if the Authority has collections higher than it needs to fulfill all requirements in the indenture, it must retire bonds. This can significantly shorten the actual maturity of the tobacco securities.

Build America Bonds (BABs) and Direct Pay Bonds are subject to an early redemption. As a result of the federal sequestration process, the BABs and Direct Pay Bond interest subsidy was cut, allowing the issuers to call their bonds at any time. Please refer to the Official Statement for more information.

Certificate of Participation bonds (COPs) may be subject to an early redemption, which means that the issuer can redeem these bonds prior to maturity. This may result in a yield lower than what was quoted to you. These bonds may default or be called at par due to funds not being allocated to pay for the lease/project. Please refer to the Official Statement for additional information.

Housing and student loan bonds may be subject to an early redemption, which means that the issuer can redeem these bonds prior to maturity. This may result in a yield lower than what was quoted to you. Please refer to the Official Statement for additional information.