EDUCATION CENTER Evaluating a Municipal Bond’s Default Risk

When considering the purchase of a municipal bond, an important consideration is a state or local government’s ability to meet its financial obligations. The likelihood that the bond’s issuer will fail to meet the requirements of timely interest payment and repayment of principal to investors is called default risk. Investors should work with a to evaluate a bond’s default risk.

Assess a State or Local Event disclosures detail for investors Government’s Financial delinquency in principal and interest Information payments, other types of defaults, unscheduled draws on debt service One way to evaluate a state or local reserves reflecting financial difficulties, government’s default risk is to assess unscheduled draws on credit available financial information. When enhancements reflecting financial a state or local government offers new difficulties, rating changes, events affecting bonds for sale, it typically discloses details the tax-exempt status of the bond, bond Access other of the offering and information about its calls, and other events. resources for financial condition in the bond’s official investors in the statement, a document similar to the Ongoing financial and event disclosures MSRB Education prospectus used for a corporate securities made by state and local governments are offering. This information is typically Center. available to the public for free through updated for each new bond sale. State and the Municipal Securities Rulemaking local governments also disclose updated Board’s Electronic Municipal Market Access financial information after the initial bond (EMMA®) website at emma.msrb.org. sale has finished through two types of continuing disclosures: financial/operating Federal securities law requires financial disclosures and event disclosures. professionals that buy and sell municipal bonds to have procedures in place Financial/operating disclosures from to obtain event and other disclosures issuers of municipal securities consists about municipal securities. Ask your of important financial information and financial professional if the state or local operating data about an issuer and/or government that has issued a particular other entity that may be obligated to bond is current on reporting of annual repay investors in the securities, frequently financial and operating data, and consider referred to as an obligated person. Such missing or past-due financial information disclosures may include, for example, the as a potential risk. issuer’s annual financial information.

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© Municipal Securities Rulemaking Board 2019.1 1 Evaluate the Credit Still, a low credit rating is an evaluation of a bond’s risk of default and investors Credit ratings are another way to evaluate should carefully consider the risks of a bond’s risk of default and, in some cases, purchasing a bond with a low credit rating. take into consideration the potential loss Bonds with low credit ratings typically carry to investors in the event of default. It is higher interest rates than those with higher important to realize that these ratings credit ratings and the higher return is are opinions of the company issuing the intended to compensate investors for the ratings and one of many factors used in higher level of risk they are assuming with Use the EMMA evaluating a municipal bond investment. the purchase. website to check Because ratings can change, investors the current credit should not assume the rating shown on the Not all bonds have credit ratings. While an rating assigned official statement when the bond was first absence of a credit rating is not, by itself, issued remains in effect if it is purchased by Fitch Ratings, an indicator of low credit quality, investors at a later date. Investors may wish to in non-rated bonds should be prepared Kroll Bond Rating ask their broker for the current credit to conduct their own independent credit Agency, Moody’s ratings on any bond they are considering analysis of the bonds. Investors Service, purchasing or use the EMMA website to Inc. or Standard & check the current credit rating assigned by Consider Payment Protection Fitch Ratings, Kroll Bond Rating Agency, Poor’s. Features Moody’s Investors Service, Inc. or Standard & Poor’s. Some municipal bonds have a repayment protection feature such as bond insurance, Investors should understand that a high letter of credit or a guarantee by another credit rating is not a seal of approval and unit of government. However, any such does not reflect or guarantee stability of guarantee depends on the financial market value or liquidity. A high rating soundness of the entity providing also does not mean that an investor will the guarantee. For this reason, when be able sell the bond at a particular time, considering such a bond, investors should especially prior to maturity, or that the be sure to take into account the credit investor will receive a particular price. rating and long-term viability of the entity providing the guarantee.

This information is for educational purposes only and provides a general overview of the subject matter and does not constitute investment, tax, business, legal or other advice.

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Evaluating a Municipal Bond’s Default Risk 2