What Is a Municipal Note?

Municipal notes are debts issued by state and local governments to fund specific capital expenditures like construction projects. There are three types of municipal notes: bond anticipation notes, tax anticipation notes, and revenue anticipation notes. These notes are issued by local and state governments to fund projects that benefit the region. Municipal notes make one payment when they mature, which includes both principal and interest payments. They are exempt from federal income tax and sometimes state and local income tax. These are short-term debt securities that usually mature within 12 months, although their maturity may be slightly shorter or longer.

Basics

Municipal notes, also known as government-issued notes, serve as a means for state and local authorities to secure funds for vital capital investments, predominantly within construction ventures. Investors find these notes particularly attractive due to their unique features. These notes come to maturity within a year or less, guaranteeing a stable income stream. Moreover, they frequently enjoy tax exemptions, either at the federal or state levels, further enhancing their appeal.

Distinctive Features of Municipal Notes

Municipal notes differ significantly from most municipal bonds in terms of interest payments. Unlike bonds, they typically make a single payment encompassing both interest and principal obligations upon reaching maturity.

While municipal notes often offer lower coupon rates compared to corporate notes of similar maturities, their tax-exempt status can result in a higher after-tax yield. These notes enjoy exemption from federal income taxes and occasionally from state and local taxes.

To assess the investment risk associated with a specific municipal note, investors should refer to the credit ratings assigned by Moody's and Standard & Poor's. Moody's ratings encompass three categories: MIG 1 (highest quality), MIG 2 (high quality), and MIG 3 (adequate quality). Standard & Poor's employs a four-tiered rating system: SP-1+, SP-1, SP-2, and SP-3, with only the first three regarded as suitable for investment. SP-3-rated municipal notes are considered speculative investments.

Varieties of Municipal Notes

Bond Anticipation Notes (BANs)

BANs, or Bond Anticipation Notes, serve as a short-term funding solution issued in anticipation of long-term financing. In cases where a new project is set to commence, the borrowing entity may face delays in issuing long-term bonds due to legal or regulatory procedures. To secure interim financing for project initiation, governmental issuers may choose to issue BANs. Once long-term bonds are issued, their proceeds are used to fulfill interest and principal payments on the BANs.

Tax Anticipation Notes (TANs)

TANs, or Tax Anticipation Notes, rely on future tax revenue to guarantee interest and principal payments. States or municipalities issue TANs to finance ongoing operations until tax revenues are collected. Subsequently, these tax revenues are employed to retire the tax anticipation notes.

Revenue Anticipation Notes (RANs)

RANs, or Revenue Anticipation Notes, have interest and principal payments secured by projected non-tax revenue from a specific project. As the project reaches completion and commences generating revenue at a future date, these earnings are used to liquidate the RAN.

Conclusion

Municipal notes are vital for financing state and local government projects, with three key types: bond anticipation notes, tax anticipation notes, and revenue anticipation notes. Their distinctive feature is a single payment covering both principal and interest upon maturity. These notes offer tax exemptions, making them attractive investments, and typically mature within a year. In essence, municipal notes are essential for local government funding and offer investors opportunities for stable returns.