The SEC’s Office of Investor Education and Advocacy is

INVESTOR BULLETIN 
Municipal Bonds:  
Understanding Credit Risk
The SEC’s Office of Investor Education and Advocacy is 
issuing this Investor Bulletin to help educate investors 
about assessing credit risks they face when purchasing  
municipal bonds, which may also be called notes or   
certificates of participation. Credit risk—or default risk—
is the risk that interest and/or principal on the securities 
will not be paid on time and in full.  Investors need to 
know who is responsible for repayment of the securities and 
the financial condition of that entity to assess the credit risk 
and decide whether to purchase the securities. It is important 
to look beyond the short-hand label given to a municipal 
bond, such as “general obligation bond” or “revenue bond,” 
or the bond’s credit rating. Investors should read the 
disclosure document, known as the “official statement,” 
which provides important details about the offering, 
including the factors described below.  
What are Municipal Bonds?
Municipal bonds are debt securities issued by states, 
cities, counties and other governmental entities to fund 
day-to-day obligations and to finance capital projects 
such as building schools, highways or sewer systems.  
By purchasing municipal bonds, you are in effect 
lending money to the issuer in exchange for a promise 
of regular interest payments, usually semi-annually, and 
the return of the original investment—or principal.  
The entity responsible for repaying the principal and 
interest on the bonds may be the issuer, or an underly-
ing borrower, known as the obligor or “obligated 
person.” Obligors could be another governmental 
entity, a for-profit firm, or a non-profit entity. The  
date on which the principal is scheduled to be repaid, 
known as the security’s maturity date, may be years in 
the future.  
Generally, the interest on municipal bonds is exempt 
from federal income tax. The interest may also be 
exempt from state and local taxes if you reside in the 
state where the bond is issued or if issued by a U.S. 
territory, such as Puerto Rico. Given the tax benefits, 
the interest on municipal bonds is usually lower than 
on taxable fixed-income securities such as corporate 
bonds.
Factors investors should consider  
when assessing the credit risk of  
municipal bonds:
1.  Types of Municipal Bonds
The type of municipal bond issued affects both the risk 
of default and the value of the municipal bond. Repay-
ment may come from the issuer, an obligor, or from a 
single tax or revenue source. There are two major types 
of municipal bonds: “general obligation bonds” and 
Investor Assistance (800) 732-0330  www.investor.gov

“revenue bonds.” Because these types come in many 
varieties, you should look beyond the short-hand label 
when deciding whether to purchase.  
n
  General obligation bonds are issued by govern-
mental entities and are not backed by revenues from a 
specific project or source.  Some general obligation 
bonds are backed by dedicated taxes on real property 
and, on occasion, other taxes. Other general obligation 
bonds are payable from general funds and are often 
referred to as backed by the “full faith and credit” of 
the governmental entity.  While in many instances 
“general obligation” means that the issuer or other 
governmental entity responsible for repaying the 
bonds has the unlimited authority to tax residents to 
pay bondholders, in other cases, the issuer or other 
governmental entity may have limited or no taxing 
authority. Investors should carefully read the official 
statement describing the general obligation bond 
before making an investment decision.
n
  Revenue bonds are backed by revenues from a 
specific project or source. There is a wide diversity 
of types of revenue bonds, each with unique credit 
characteristics. For example, municipal entities 
frequently issue securities on behalf of other  
borrowers such as non-profit colleges or hospitals  
or certain for-profit entities. These underlying 
“conduit” borrowers typically agree to repay the 
issuer, who pays the interest and principal on the 
securities solely from the “revenue” provided by the 
conduit borrower. Investors should carefully read 
the official statement describing the revenue 
bond, and understand both the identity of the 
conduit borrower, if any, and what revenues are 
actually pledged to back the bonds, before making 
an investment decision.
2.  Non-Recourse Financings 
Some revenue bonds are “non-recourse,” meaning that 
if the revenue stream dries up, or if payments on the 
bonds are otherwise not paid, the bondholders do not 
have a claim on the underlying revenue source or 
against the conduit borrower. In instances where a 
conduit borrower fails to make a payment to the 
municipal issuer, the issuer is usually not required to 
pay the bondholders. For these reasons, it is essential to 
understand the source of the revenues that will be used  
to repay the bonds.      
3.  Purpose of the Financing   
Municipal bond default rates vary considerably depend-
ing on a variety of factors, including the types of bonds 
issued and whether the ultimate obligor is a municipal 
entity or a non-municipal entity (i.e., a conduit bor-
rower). For example, if you are considering purchasing 
municipal securities that finance speculative projects, 
including those involving for-profit businesses, pay 
close attention to the potential risks involved. The 
official statement for this kind of offering usually will 
include a feasibility study showing the key assumptions 
made in evaluating the project. Understanding those 
assumptions can help you evaluate the risks.       
4.  Financial Condition of the Issuer or  
Other Obligor   
A key concern is whether the issuer or other obligor 
will be able to pay interest and principal in full. To 
evaluate the financial condition of the issuer or other 
obligor, consider (among other things):   
n
  Debt and other longer-term liabilities payable from  
or impacting the same source of revenue as the bonds, 
including, if applicable, pension and other post- 
employment benefit obligations of the municipal 
bond issuer;
Investor Assistance (800) 732-0330  www.investor.gov
2

Investor Assistance (800) 732-0330  www.investor.gov
3
n
  The underlying local economy, including employ-
ment, income, wealth, and tax burden; and
n
  The audited financial statements of the issuer or 
obligor, including both revenues and expenses.
5.  Other Sources of Funds to Pay  
Principal and Interest   
While some municipal bonds are general obligation 
bonds, others are repaid not by an issuer or other 
obligor, but from a specific payment stream. You 
should evaluate the viability of the sources of revenue  
to be used to make these payments.  In evaluating the 
source of payment for the bonds, you should consider 
(among other things): 
n
  Economic or social trends that may limit demand for 
particular goods or services (such as gasoline or 
cigarettes) when those goods or services are being 
taxed to fund the repayment of the securities; and
n
  Statutory limits on raising revenues, such as the need 
for voter approval.
What are Credit Ratings?
While some investors find it helpful to consider credit 
ratings when making an investment decision, it is 
important that you not rely solely on credit ratings 
when deciding whether to purchase municipal bonds. 
Investors need to undertake their own independent 
review of the municipal bonds’ risk by reading the 
official statement and other relevant information 
described below.
Credit ratings are assessments of municipal bonds’ 
credit risk at a particular point in time. You should be 
aware that because credit ratings may change over time, 
the credit rating found on the official statement may 
not be the credit rating of the municipal bonds if you 
purchase them on a subsequent date. Investors should 
also be aware that, in general, credit rating agencies are 
paid by the issuer whose municipal bonds they are rating.
Credit ratings are only assessments by credit rating 
agencies of the credit risk associated with a municipal 
bond. Each credit rating agency evaluates credit risk 
based on its own standards, applies its own ratings 
methodology, and weighs the various factors in the 
methodology differently. Credit ratings are not invest-
ment advice, guarantees of credit quality or of future 
credit risk, or indications that an investment is suitable. 
They are designed to address only one aspect of an 
investment decision—credit risk. As an investor, you 
may or may not agree with the credit rating.             
Where should I look for information  
regarding municipal securities?
In most cases, official statements as well as updated 
information regarding the issuer and the municipal 
bonds can be found on the Electronic Municipal 
Market Access (EMMA) website, www.emma.msrb.org.  
The issuer’s financial information is often updated each 
year. In addition, many municipal bond issuers provide 
“material event notices” that contain information 
concerning, among other things, delinquent principal 
and interest payments, other types of defaults, rating 
changes, events impacting the tax status of the securities, 
and bond redemptions or calls. EMMA also has some 
credit ratings information.   
Often, the official statement contains a section titled 
“investment risk factors” or “investment consider-
ations,” which provides information relevant to your 
investment decision. In addition, pertinent financial 
information regarding the issuer generally may be 
found in an appendix attached to the official statement.
This publication focuses on credit risk. Investments in 
municipal bonds entail other risks, such as call risk, 
interest rate risk, inflation risk, and liquidity risk.  
Please refer to the material listed below for more 
information on these risks.

Investor Bulletin: Municipal Bonds (available at 
http://www.sec.gov/investor/alerts/municipal-
bonds.htm)
FINRA and MSRB Investor Alert: Municipal 
Bonds—Staying on the Safe Side of the Street in 
Rough Times (available at http://www.finra.org/
investors/protectyourself/investoralerts/bonds/
p118923)
Related Information
The Office of Investor Education and Advocacy 
has  provided  this  information  as  a  service  to  
investors. It is neither a legal interpretation nor 
a  statement  of  SEC  policy.  If  you  have  ques-
tions  concerning  the  meaning  or  application  
of a particular law or rule, please consult with 
an attorney who specializes in securities law.
SEC Pub. No. 134 (12/12)

INVESTOR BULLETIN 
Municipal Bonds:  
Understanding Credit Risk
The SEC’s Office of Investor Education and Advocacy is 
issuing this Investor Bulletin to help educate investors 
about assessing credit risks they face when purchasing  
municipal bonds, which may also be called notes or   
certificates of participation. Credit risk—or default risk—
is the risk that interest and/or principal on the securities 
will not be paid on time and in full.  Investors need to 
know who is responsible for repayment of the securities and 
the financial condition of that entity to assess the credit risk 
and decide whether to purchase the securities. It is important 
to look beyond the short-hand label given to a municipal 
bond, such as “general obligation bond” or “revenue bond,” 
or the bond’s credit rating. Investors should read the 
disclosure document, known as the “official statement,” 
which provides important details about the offering, 
including the factors described below.  

What are Municipal Bonds?
Municipal bonds are debt securities issued by states, 
cities, counties and other governmental entities to fund 
day-to-day obligations and to finance capital projects 
such as building schools, highways or sewer systems.  
By purchasing municipal bonds, you are in effect 
lending money to the issuer in exchange for a promise 
of regular interest payments, usually semi-annually, and 
the return of the original investment—or principal.  
The entity responsible for repaying the principal and 

interest on the bonds may be the issuer, or an underly-
ing borrower, known as the obligor or “obligated 
person.” Obligors could be another governmental 
entity, a for-profit firm, or a non-profit entity. The  
date on which the principal is scheduled to be repaid, 
known as the security’s maturity date, may be years in 
the future.  

Generally, the interest on municipal bonds is exempt 
from federal income tax. The interest may also be 
exempt from state and local taxes if you reside in the 
state where the bond is issued or if issued by a U.S. 
territory, such as Puerto Rico. Given the tax benefits, 
the interest on municipal bonds is usually lower than 
on taxable fixed-income securities such as corporate 
bonds.

Factors investors should consider  
when assessing the credit risk of  
municipal bonds:

1. 	Types of Municipal Bonds

The type of municipal bond issued affects both the risk 
of default and the value of the municipal bond. Repay-
ment may come from the issuer, an obligor, or from a 
single tax or revenue source. There are two major types 
of municipal bonds: “general obligation bonds” and 

Investor Assistance (800) 732-0330 	 www.investor.gov

www.investor.gov


“revenue bonds.” Because these types come in many 
varieties, you should look beyond the short-hand label 
when deciding whether to purchase.  

n 	 General obligation bonds are issued by govern-
mental entities and are not backed by revenues from a 
specific project or source.  Some general obligation 
bonds are backed by dedicated taxes on real property 
and, on occasion, other taxes. Other general obligation 
bonds are payable from general funds and are often 
referred to as backed by the “full faith and credit” of 
the governmental entity.  While in many instances 
“general obligation” means that the issuer or other 
governmental entity responsible for repaying the 
bonds has the unlimited authority to tax residents to 
pay bondholders, in other cases, the issuer or other 
governmental entity may have limited or no taxing 
authority. Investors should carefully read the official 
statement describing the general obligation bond 
before making an investment decision.

n 	 Revenue bonds are backed by revenues from a 
specific project or source. There is a wide diversity 
of types of revenue bonds, each with unique credit 
characteristics. For example, municipal entities 
frequently issue securities on behalf of other  
borrowers such as non-profit colleges or hospitals  
or certain for-profit entities. These underlying 
“conduit” borrowers typically agree to repay the 
issuer, who pays the interest and principal on the 
securities solely from the “revenue” provided by the 
conduit borrower. Investors should carefully read 
the official statement describing the revenue 
bond, and understand both the identity of the 
conduit borrower, if any, and what revenues are 
actually pledged to back the bonds, before making 
an investment decision.

2. 	Non-Recourse Financings 

Some revenue bonds are “non-recourse,” meaning that 
if the revenue stream dries up, or if payments on the 
bonds are otherwise not paid, the bondholders do not 
have a claim on the underlying revenue source or 
against the conduit borrower. In instances where a 
conduit borrower fails to make a payment to the 
municipal issuer, the issuer is usually not required to 
pay the bondholders. For these reasons, it is essential to 
understand the source of the revenues that will be used  
to repay the bonds.      

3. 	Purpose of the Financing   
Municipal bond default rates vary considerably depend-
ing on a variety of factors, including the types of bonds 
issued and whether the ultimate obligor is a municipal 
entity or a non-municipal entity (i.e., a conduit bor-
rower). For example, if you are considering purchasing 
municipal securities that finance speculative projects, 
including those involving for-profit businesses, pay 
close attention to the potential risks involved. The 
official statement for this kind of offering usually will 
include a feasibility study showing the key assumptions 
made in evaluating the project. Understanding those 
assumptions can help you evaluate the risks.       

4. 	Financial Condition of the Issuer or  
Other Obligor   

A key concern is whether the issuer or other obligor 
will be able to pay interest and principal in full. To 
evaluate the financial condition of the issuer or other 
obligor, consider (among other things):   

n 	 Debt and other longer-term liabilities payable from  
or impacting the same source of revenue as the bonds, 
including, if applicable, pension and other post- 
employment benefit obligations of the municipal 
bond issuer;

Investor Assistance (800) 732-0330 	 www.investor.gov

2

www.investor.gov


Investor Assistance (800) 732-0330 	 www.investor.gov

3

n 	 The underlying local economy, including employ-
ment, income, wealth, and tax burden; and

n 	 The audited financial statements of the issuer or 
obligor, including both revenues and expenses.

5. 	Other Sources of Funds to Pay  
Principal and Interest   

While some municipal bonds are general obligation 
bonds, others are repaid not by an issuer or other 
obligor, but from a specific payment stream. You 
should evaluate the viability of the sources of revenue  
to be used to make these payments.  In evaluating the 
source of payment for the bonds, you should consider 
(among other things): 

n 	 Economic or social trends that may limit demand for 
particular goods or services (such as gasoline or 
cigarettes) when those goods or services are being 
taxed to fund the repayment of the securities; and

n 	 Statutory limits on raising revenues, such as the need 
for voter approval.

What are Credit Ratings?
While some investors find it helpful to consider credit 
ratings when making an investment decision, it is 
important that you not rely solely on credit ratings 
when deciding whether to purchase municipal bonds. 
Investors need to undertake their own independent 
review of the municipal bonds’ risk by reading the 
official statement and other relevant information 
described below.

Credit ratings are assessments of municipal bonds’ 
credit risk at a particular point in time. You should be 
aware that because credit ratings may change over time, 
the credit rating found on the official statement may 
not be the credit rating of the municipal bonds if you 
purchase them on a subsequent date. Investors should 

also be aware that, in general, credit rating agencies are 
paid by the issuer whose municipal bonds they are rating.

Credit ratings are only assessments by credit rating 
agencies of the credit risk associated with a municipal 
bond. Each credit rating agency evaluates credit risk 
based on its own standards, applies its own ratings 
methodology, and weighs the various factors in the 
methodology differently. Credit ratings are not invest-
ment advice, guarantees of credit quality or of future 
credit risk, or indications that an investment is suitable. 
They are designed to address only one aspect of an 
investment decision—credit risk. As an investor, you 
may or may not agree with the credit rating.             

Where should I look for information  
regarding municipal securities?
In most cases, official statements as well as updated 
information regarding the issuer and the municipal 
bonds can be found on the Electronic Municipal 
Market Access (EMMA) website, www.emma.msrb.org.  
The issuer’s financial information is often updated each 
year. In addition, many municipal bond issuers provide 
“material event notices” that contain information 
concerning, among other things, delinquent principal 
and interest payments, other types of defaults, rating 
changes, events impacting the tax status of the securities, 
and bond redemptions or calls. EMMA also has some 
credit ratings information.   

Often, the official statement contains a section titled 
“investment risk factors” or “investment consider-
ations,” which provides information relevant to your 
investment decision. In addition, pertinent financial 
information regarding the issuer generally may be 
found in an appendix attached to the official statement.
This publication focuses on credit risk. Investments in 
municipal bonds entail other risks, such as call risk, 
interest rate risk, inflation risk, and liquidity risk.  
Please refer to the material listed below for more 
information on these risks.

www.investor.gov
http://www.sec.gov/cgi-bin/goodbye.cgi?www.emma.msrb.org


Investor Bulletin: Municipal Bonds (available at 
http://www.sec.gov/investor/alerts/municipal-
bonds.htm)

FINRA and MSRB Investor Alert: Municipal 
Bonds—Staying on the Safe Side of the Street in 
Rough Times (available at http://www.finra.org/
investors/protectyourself/investoralerts/bonds/
p118923)

Related Information The Office of Investor Education and Advocacy 
has provided this information as a service to 
investors. It is neither a legal interpretation nor 
a statement of SEC policy. If you have ques-
tions concerning the meaning or application 
of a particular law or rule, please consult with 
an attorney who specializes in securities law.

SEC Pub. No. 134 (12/12)

http://www.sec.gov/investor/alerts/municipalbonds.htm
http://www.sec.gov/cgi-bin/goodbye.cgi?www.finra.org/investors/protectyourself/investoralerts/bonds/p118923
http://www.sec.gov/cgi-bin/goodbye.cgi?www.finra.org/investors/protectyourself/investoralerts/bonds/p118923
http://www.sec.gov/cgi-bin/goodbye.cgi?www.finra.org/investors/protectyourself/investoralerts/bonds/p118923