America relies on muni bonds. States, cities, counties, school districts, municipal utilities and other governmental agencies issue municipal bonds to raise cash to fund the government services and public infrastructure that support the way we live. Buyers of muni bonds are effectively lending money to the issuer or obligor. In return, they receive interest payments, typically semi-annually, and principal repayment at the maturity of their bond. Maturities vary from less than a year to 30 years or even occasionally longer.
There are two principal types of muni bonds:
General obligation bonds, backed by the “full faith and credit” of the obligor, typically a state or local governmental unit, which must repay the debt from any unencumbered funds available and raise taxes if necessary to pay the debt.
Revenue bonds, secured by a priority claim on revenues from a specific source, such as those from municipal water, sewer, transportation or electric systems. Only the dedicated revenues are available to pay the debt, and investors’ claim on those revenues should be protected in a bankruptcy proceeding.
The income from most muni bonds is exempt from Federal and, in many cases, state and local taxes. Others are not tax-exempt. It is important to understand the tax treatment of any bond you purchase and the yield it provides when the tax benefit is included (the taxable-equivalent yield).
Insuring against the payment risk in muni bonds
Both institutional and individual investors frequently purchase muni bonds for their investment portfolios. However, as a handful of recent well-publicized municipal defaults and bankruptcies show, muni bonds do entail risks. To manage these risks, MAC offers reliable investment protection.
Muni bond insurance is designed to insulate investors from the risk that a municipality may not make its bond payments on time. Although we do not guaranty market value and market liquidity, it also has been shown to support market value and market liquidity when a bond issuer is seen to be in financial distress. Muni bond insurance guarantees that the holder of a municipal bond will receive scheduled interest and principal payments when due, even if the municipal issuer fails to make these payments. It is literally an insurance policy that protects investors against an issuer’s payment default.
Financial guaranty insurance companies write bond insurance. You may hear these companies called "bond insurers," "financial guarantors," "monoline insurance companies" or just "monolines." All these terms refer to the same category of companies, which operate solely as guarantors of financial obligations and are subject to specialized regulation that restrict their business to financial guaranty and related types of insurance (hence the name "monolines"). Monolines must be licensed to write insurance by the state insurance department in each state where they insure bonds and generally must meet their obligations to policyholders before other creditors. Under financial guaranty statutes, municipal bond insurers must comply with capital, liquidity and reserving requirements, as well as limits on their financial guaranty exposures.