4.4 Municipal Bond Analysis

Municipal Credit Ratings

Rating agencies estimate the probability that an issuer repays on time. Memorize the investment-grade cutoff — it is one of the most tested single facts in this chapter.

• Investment grade is Baa3 / BBB- or higher — suitable for most retail and fiduciary accounts.
• Speculative grade is Ba1 / BB+ or lower — higher default risk, higher yield, often called high-yield or junk.
• Modifiers: Moody's appends 1/2/3 (Aa1 > Aa2 > Aa3); S&P and Fitch use + and - (AA+ > AA > AA-).

Exam Tip: A bond rated Ba1 is one notch below investment grade, not the top of it — Baa3 is the lowest rung that still counts as investment grade.

The Official Statement (OS)

Munis are exempt from SEC registration, so there is no statutory prospectus. The Official Statement is the functional equivalent — the issuer's primary disclosure document for a new issue.

Preliminary Official Statement (POS)

• Also called the "red herring," distributed during the offering period to gauge interest.
• Contains nearly all OS information except the final price and coupon (interest rate).
• Under MSRB Rule G-32, the dealer must deliver the final OS to a customer by settlement, and the OS is posted to EMMA.

Continuing Disclosure — SEC Rule 15c2-12

Dealers may only underwrite a primary offering if the issuer has agreed in a continuing disclosure agreement to keep the market informed. Under SEC Rule 15c2-12 the issuer must file with EMMA:

• Annual financial information and audited statements.
• Material event notices within 10 business days, including: principal/interest payment delinquencies, rating changes, defaults, unscheduled draws on reserves, bond calls, defeasances, and adverse tax events affecting the exemption.

EMMA (Electronic Municipal Market Access)

EMMA, at emma.msrb.org, is the MSRB's free public website and the central repository for the muni market. An investor researching a bond finds on EMMA:

• Official statements and continuing disclosure filings.
• Real-time trade prices and yields (post-trade transparency).
• Credit ratings, including both the insured and underlying rating.
• Call, refunding, and advance-refunding notices.

Exam Tip: EMMA — not the SEC's EDGAR — is where muni disclosure lives. EDGAR holds corporate filings.

Bond Insurance and Credit Enhancement

Municipal bond insurance is a guarantee that, if the issuer defaults, the insurer makes timely payment of principal and interest. It does not protect against market-value swings or interest-rate risk.

• An insured bond trades at the insurer's rating when that rating is higher than the issuer's own.
• The underlying (unenhanced) rating — the issuer's standalone rating — still matters, because an insurer can be downgraded. After the 2008 crisis, several monoline insurers were downgraded and the product became far less common.
• Major active insurers include Assured Guaranty and Build America Mutual (BAM).
• Other enhancements include a letter of credit (LOC) from a bank and state aid intercept programs.

What Drives Marketability

Key Point: Marketability (how easily a bond is sold) is distinct from credit quality, though a high rating helps both.

Bond Counsel and the Legal Opinion

Every new municipal issue carries a legal opinion from bond counsel, an independent law firm. The opinion addresses two things: that the bonds are a valid and binding obligation of the issuer, and that the interest is exempt from federal income tax. An unqualified opinion states this without reservation; a qualified opinion flags a contingency or limitation. Bonds delivered without an opinion are sold "ex-legal," which the dealer must disclose because it removes a key assurance investors rely on.

Refundings: Pre-Refunded and Escrowed-to-Maturity

Issuers often refinance old high-coupon debt by issuing new bonds and parking the proceeds in an escrow of U.S. government securities. The original bonds become refunded (or pre-refunded) bonds:

Because the escrow holds government securities, pre-refunded munis usually earn the highest rating, and their effective maturity shortens to the call date — important for a customer's duration and reinvestment expectations.

A Quick Disclosure Map

Exam Tip: If a question describes a bond "backed by an escrow of U.S. government securities maturing at the first call date," the answer is a pre-refunded bond, and its credit is treated as government-quality regardless of the issuer's standalone rating.