Homework is Needed Prior to Investing in Municipal Bonds


With declining revenue streams, underfunded pensions, and no insurance, municipal bonds can be treacherous and unsuitable for investors who lack the background and resources to performance due diligence before investing. “You cannot rely upon a third party like an insurance company doing the due diligence for you and putting their triple-A wrap on it,” one municipal bond portfolio manager was quoted as saying, adding: “That methodology is gone. So you have to go back to basics and do your own homework.” (“Muni Bonds: Spotting Red Flags,” WSJ Blogs).

Property tax collections have declined in 2012, and with three California municipalities having filed for bankruptcy this year (Stockton, Mammoth Lakes and San Bernadino), observers worry that defaults are becoming less rare.

While bonds backed by a specific stream of income have been considered safer for investors than general obligation bonds, that may be changing, too. Jefferson County, Alabama is asking a bankruptcy court to slash payments to investors in $3 billion of bonds backed by revenue from its sewer system.

The problem is that ordinary investors and investment advisors are generally not well-equipped to perform the necessary due diligence on municipal bonds. While there may be “red flags” that can be spotted by experienced analysts, the blog concludes that “no two munis are alike, nor is one metric a surefire way to assess fiscal health.”

The bottom line is that investors should tread carefully in the municipal bond area. If an investor lacks the ability to prudently evaluate municipal bond alternatives, guidance from a knowledgeable financial adviser should be sought.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.