Municipal Bonds Gear Up to Support City Infrastructure Investment

Alan Appelbaum

January 20, 2023


Municipal bonds are a vital source of revenue for municipalities across the country, and their increasing availability is proving to be a significant boon for cities looking to invest in their infrastructure. However, the market has become more complicated over the past few years as credit risk has become a big factor. A new study explores the impact of environmental, social, and governance (ESG) factors on credit risk and how this can affect muni bond yields.

General obligation bonds

General obligation Municipal bonds are municipal securities issued by state and local governments. They are usually used to fund government projects that serve the public community.

In many cases, interest payments are exempt from state income taxes. This means that munis are attractive to investors looking for income-producing opportunities.

The primary advantage of general obligation bonds is that they allow local governments to raise funds for projects rather than requiring direct revenue. For example, proceeds from a general obligation bond may be used to fund affordable housing programs, transportation improvements, or public parks.

General obligation bonds are backed by taxing power and issuer credit. Unlike revenue bonds, they are not secured by assets. However, GO bonds are only sometimes easy to secure. Consequently, some jurisdictions limit the amount of outstanding general obligation debt.

Revenue bonds

Investing in municipal bonds may sound like a bad idea, but the fact is that munis can help fund public improvements in your state or local area. They can be used to pay for public school construction, hospital renovations, water treatment plants, and bridges. These investments have the potential to generate tax-free income for investors.

There are two main types of munis: revenue and GO bonds. Both types of bonds pay interest periodically. The former are issued to cover costs, while the latter is backed by the issuer’s capacity to generate revenue over time.

Some munis exceed the Internal Revenue Service’s private security limits. That’s because of the risk associated with investing in the bond market.

Private activity bonds

Municipal bonds, also known as munis, provide an investment opportunity to fund public projects that benefit the community and the environment. Investors can use munis to support local schools, hospitals, or public infrastructure projects. Investing in municipal bonds can generate interest payments and may be tax-free.

The federal government has made numerous efforts to promote infrastructure investment. One way is through the Build America Bonds program. This program provided investors with a 35% federal tax credit, similar to what you get when investing in a municipal bond.

Another option is the private-activity bond. These bonds provide tax-exempt financing for certain public-private partnerships. They can be used for any type of facility, including schools, local utilities, and residential rental projects.

A third option is to invest in taxable municipal bonds for public infrastructure projects. Qualified public infrastructure bonds are not subject to the alternative minimum tax.

Tax-equivalent yields

A tax-equivalent yield is a valuable tool for measuring and comparing the returns between taxable bonds and munis. Taxes are an essential factor in any financial strategy. But they are also complex. Therefore, it pays to be aware of your options before deciding on the proper bond for your portfolio.

To invest in a taxable bond, you must first determine your personal income tax rate. This can be done by using the tax calculator provided by the IRS. The results can vary widely, depending on your income level.

It would be best to consider your area’s state and local tax rates. Some states offer lower tax rates than the federal government.

ESG factors on credit risk

A new report from the Public Policy Research Institute (PRI) indicates that the US municipal bond market is increasingly gearing up to support city infrastructure investments based on ESG factors. However, many industry participants still need to be united on how best to incorporate the concept into their strategies.

Public and private Issuers can use ESG factors to provide information on how well they handle environmental, social, and governance issues. This information can help investors identify opportunities and risks.

While ESG factors have been an increasingly important consideration for equities investors over the past decade, muni investors have been slower to incorporate the factors into their security analysis. The challenge is that the market needs a third-party ESG rating system.