- What does it mean when a bond or note is tax-exempt?
- What does it mean when a bond or note is taxable?
- What are some benefits of purchasing municipal securities?
- What are some risks involved in investing in municipal securities?
- What are the key features of State municipal securities?
- What if I want to sell my municipal securities prior to maturity?
- How do I compare the yields on tax-exempt municipal securities to taxable investment alternatives?
- What is the difference between municipal securities in the primary and secondary market?
Program Specific FAQs
- What is a State of California General Obligation (GO) bond?
- What is a Lease Revenue Bond (LRB) bond?
- What is the security for LRBs?
- What is the State Public Works Board (SPWB)?
- What is a State of California Revenue Bond?
- What are the State of California’s Revenue Anticipation Notes (RANs)?
- What is the final maturity of RANs?
- How do I interpret the credit ratings on RANs?
- What is the security for the payment of the principal and interest on RANs?
- What is a Grant Anticipation Revenue Vehicle (GARVEE) Bond?
- What is the security for GARVEEs?
Tax-exempt means that, in the opinion of legal counsel, the interest you earn on the security is exempt from federal income taxes and from California personal income taxes. Investors should consult their brokers or other financial advisors to obtain comparisons between tax-exempt California municipal bonds or notes and taxable investment alternatives. Not all State bonds are tax-exempt. For additional information about the tax status of specific bonds, read the “Tax Matters” section of the official statement for that particular offering. Official statements may be obtained by contacting the Investor Relations Unit at (800) 900-3873.
The interest earned on most GO bonds issued by the State of California is exempt from federal and state income tax, subject to rules relating to tax-exempt bonds set forth in the Internal Revenue Code. However, because of the programs funded by these bonds, it is not certain the bonds meet all of the tax rules so the State’s bond counsel will not provide its normal opinion that interest on these bonds is exempt from federal income taxation. The interest income on these bonds is still exempt from State of California personal income tax. Investors should consult their brokers or other financial advisors to obtain comparisons between taxable State GO bonds and tax-exempt investment alternatives. Read the “Tax Matters” section of the official statement for the bond sale to learn about the bonds’ tax status.
Municipal bonds and notes can be an important part of a diversified investment portfolio. Because bonds and notes typically have a predictable stream of payments of principal and interest, many people invest in them to preserve and increase their capital, or to receive dependable interest income. Additionally, the interest earned on municipal securities typically is exempt from federal and state income taxes.
It is important to remember that investment objectives, and the best strategies for achieving those objectives, depend on an individual investor’s particular circumstances. The tax advantage investors reap from tax-exempt securities will vary according to their income level.
- Credit Risk - Risk that the issuer is unable to pay scheduled principal and interest on a timely basis. To evaluate the credit quality of an issuer, examine its credit rating and review the Preliminary Official Statement of the offering, which contains detailed financial information of the issuer.
- Interest Rate Risk - When interest rates decrease, bond and note prices increase, and when interest rates increase, bond and note prices decrease. Interest rate risk is the risk that changes in interest rates may reduce (or increase) the market price of a security. For investors who own a bond or note until its maturity, interest rate risk is not a concern.
- Interest Rate - The State pays interest to investors in exchange for the use of the loaned money. The interest rate is a percentage of the principal (the amount borrowed), accruing over a specified period. Interest on bonds or notes with fixed interest rates typically is compounded and paid semiannually. Interest on bonds or notes with variable interest rates accrues at a rate which changes periodically based on specific criteria.
- Price - The price is the amount investors are willing to pay based on certain variables, including current market yields, supply and demand, credit quality, maturity and tax status. Keep in mind that price and yields move in opposite directions. When market yields increase, the value of a bond or note decreases, and vice versa.
- Yield - The yield generally refers to the return an investor earns on the bond or note. The yield is calculated in two ways: based on the market price and interest rate; or by taking into account a number of factors, including interest rate, market price, maturity date and the time between interest payments. Investors should consult their brokers or other financial advisors to learn more about yield.
- Maturity - Maturity is the date when the principal on the bond or note is scheduled to be repaid to the investor. The State generally sells bonds that have maturities between 1 and 30 years. In general, the further out the maturity date, the higher the investor’s yield.
- Redemption Provisions - Some bonds or notes contain provisions that allow the State to redeem, or “call,” all or a portion of the bonds or notes, at specific prices, prior to their maturity dates. Bonds frequently are called when interest rates are lower than when the State sold the bonds. Bonds or notes with redemption provisions usually offer investors higher yields to compensate for the risk that the bonds might be called early. When the State calls a bond or note, it pays the holder the principal amount and any interest earned since the last interest payment. However, the holder does not receive the interest that would have been earned if the bond had been allowed to reach its maturity date. Holders of callable bonds or notes are notified of impending calls. Investors can find out if their State bond or note has been called by visiting the State Treasurer’s website or by calling Investor Relations Unit at (800) 900-3873. Investors should have their CUSIP (Committee on Uniform Securities Identification Procedures) number – a unique identifying number – available when calling.
- Creditworthiness - Most municipal bonds and notes are rated by one or more of the three major rating agencies: Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s. A credit rating is an independent assessment of the creditworthiness of the bonds. It measures the probability of timely repayment of principal and interest of a bond or note. Higher credit ratings indicate the rating agency’s view that there is a greater probability the investment will be repaid. More information about credit ratings, the current ratings for the State’s GO bonds and a history of the State’s GO bond ratings.
Most municipal securities may be sold prior to maturity with the assistance of a brokerage firm. If an investor sells a municipal security prior to maturity, he or she may receive more or less than the original price depending on prevailing market interest rates, supply and demand, and perceived credit quality of the securities, among other variables. In addition, investors should consult a tax advisor for any tax implications.
The taxable equivalent yield is the return on a taxable investment that makes it equal to the return on a tax-exempt security of the same credit quality. The table below shows the taxable equivalent yield for a range of tax-exempt yields based on different federal tax brackets and the 9.3% California State tax bracket.
Taxable Equivalent Yields
|Tax-Exempt Bond Yield||25.0% Federal Tax Bracket||28% Federal Tax Bracket||33.0% Federal Tax Bracket||35.0% Federal Tax Bracket|
The Securities Industry and Financial Markets Association (SIFMA) maintains a calculator on its website (www.investinginbonds.com) that computes the taxable equivalent yield of a tax-exempt security, depending on an individual’s State and Federal income tax bracket.
When an issuer sells a new issue, it is referred to as a primary market sale. In a new issue, all of the terms are set, including the price and interest rates, and the securities are sold to investors, with the issuer receiving the proceeds of the sale. The initial sales commission paid to broker-dealers is paid by the issuer, such as the State of California, from the proceeds. A retail investor who would like to participate in a primary market transaction must have an account with, and purchase the securities through, a brokerage firm serving as one of the issuer’s underwriters or selling group members.
A secondary market transaction does not involve the issuer, but is a transaction between two investors – a buyer and a seller. Secondary market transactions involve a brokerage firm which acts either as a liaison between the buyer and seller, or as a buyer or seller itself. Buyers pay sales commissions to brokerage firms to compensate them for their services in facilitating the transaction. Market conditions, such as prevailing interest rates, supply and demand, and credit quality, among other variables, determine the price, which likely will differ from the original price.
When you buy a GO bond issued by the State of California, you make a loan to the State. The State uses your money to build schools, university buildings, hospitals, housing, roads, mass transit facilities, parks, water delivery systems and other projects. The bond you receive in return for your money is, in effect, an IOU – the State’s promise to repay the amount of money borrowed (the principal), plus interest, in a specified period of time. GO bonds are backed by the full faith and credit of the State. The principal and interest on all GO bonds are paid out of the State’s general fund.
LRBs are a form of long-term borrowing the State uses to finance public improvements, including state office buildings, state universities, prisons, and food and agricultural facilities. Like a GO bond, an LRB is, in effect, an IOU. Unlike GO bonds, however, LRBs are not backed by the full faith and credit of the State, and may be authorized by law without voter approval.
The revenue stream backing LRBs consists of lease payments made by the governmental agency which uses the facility to the governmental financing entity which finances and constructs the facility. The financing entity is the State Public Works Board (SPWB). The SPWB constructs the facility, issues the LRBs bonds and leases the facility to the governmental agency user until the LRB is paid in full. In most cases, lease payments by the governmental agency using the facility are made from annual appropriations from the State general fund, and are used by the SPWB to make debt service payments on LRBs. For full information on the security for specific LRBs, read the Preliminary Official Statement for the offering.
The SPWB was created in 1946 as an entity of state government. State law empowers the SPWB to, among other things, acquire, construct, improve, equip, maintain, operate, and lease public buildings and related facilities for use by state agencies. The law authorizes the SPWB to issue revenue bonds to finance and refinance the cost of its projects authorized by the Legislature. The SPWB cannot pledge the credit or taxing power of the State, or any of its agencies, to pay the SPWB’s debt obligations.
Revenue bonds are a form of long-term borrowing state agencies use to finance an income-generating project, such as water projects, higher education facilities or other public facilities built with the proceeds of the financing. Income generated by the project goes first toward meeting debt service on the bonds (i.e., paying interest to bondholders) and retiring the bonds at maturity. Unlike GO bonds, revenue bonds are not backed by the State’s full faith and credit, or its taxing authority.
RANs are short-term notes that fund the State’s cash management needs during a fiscal year. Each note is a promise by the State to repay investors the amount of money borrowed (the principal), plus interest, from the States available monies at the end of that fiscal year.
Generally, RANs mature on the last day of the fiscal year (June 30) in which they were issued.
There are specific credit rating categories for short-term investments such as the State’s RANs. Short-term credit ratings range from "F1+/MIG 1/SP-1+" as the highest to "F4/MIG 4/SP-4" as the lowest investment grade ratings. More information about short-term municipal rating categories.
RANs are payable from all available monies in the State general fund, subject to use of such money for certain higher priority payments owed by the State. Those higher expenditure priorities include: payments required to public schools and universities; payments of debt service on general obligation bonds; repayment of loans by the general fund to State special funds which advanced moneys to the general fund; payment of State employee salaries, pension obligations; and certain other payments determined by court orders to be owed before payment of RANs. In order to obtain sufficient funds to pay RANs, the general fund may borrow money from the Special Fund for Economic Uncertainties and other special funds in the State treasury which have excess fund balances (called "internal borrowable resources"). Read the Preliminary Official Statement for a specific offering to obtain more information about the cash flow projections and sources of payment for RANs.
Federal Highway Grant Anticipation Revenue Vehicles (GARVEE) Bonds are another form of borrowing, which the State uses to finance the construction of critical transportation infrastructure projects. By California Transportation Commission policy, GARVEE bonds have a 12-year maximum term.
A GARVEE Bond is, in effect, an IOU and may be issued without voter approval. GARVEEs are not backed by the full faith and credit of the State or its taxing authority, and are not payable from any funds of the State, except certain Federal Transportation Funds pledged by the California Transportation Commission (CTC).
The revenue stream backing GARVEEs consists of certain Federal Transportation Funds pledged by the California Transportation Commission (CTC) to payment of the GARVEEs. Federal Transportation Funds are distributed to the State by the federal government pursuant to federal law. In connection with the GARVEE program, the California Department of Transportation has entered into the Federal Aid Agreement with the Federal Highway Administration (FHWA) to provide for reimbursement of Debt Service and other bond-related costs associated with federal-aid highway projects approved by the FHWA and financed with GARVEEs. These reimbursements are included in the Federal Transportation Fund pledged to pay the GARVEE Bonds. For full information on the security for specific GARVEEs, read the Preliminary Official Statement for the offering.