Over the past month, I've been getting a lot of questions from clients regarding specific credit events in the municipal bond market. Recent credit downgrades and bankruptcies clearly have some muni investors on edge.

The past few months have certainly been a bit of a roller coaster ride for the municipal market. In December, I wrote about the fear of a potential loss of the tax-exempt status of municipal bonds, which drove a sell-off in the muni market. After the Fiscal Cliff was resolved and it was clear munis would remain exempt from federal taxes, investors flocked back to the sector and bond prices rose. Then in March we saw another pullback, potentially driven by high net worth investors selling their munis and using the proceeds to pay 2012 tax bills.

On top of all of this is news about the credit worthiness of specific municipal issuers.

By Timothy Strauts

Municipal bonds had another good year in 2012 as interest rates continued to fall and, despite making a number of high profile headlines, municipal bankruptcies were contained. With interest rates on municipal bonds at 45-year lows, what can investors expect in 2013?

Fiscal Cliff
The "Fiscal Cliff" compromise answered the question as to whether interest on municipal bonds would be taxed in 2013. Municipal bonds avoided all the various proposals to eliminate or reduce their tax exemption. In fact, the increase in the top income tax rate to 39.6% from 35.0% may make tax-free municipals more attractive for some high income investors. After a sell-off in December the municipal market has rallied as investors have shaken off concerns about potential changes to muni bonds' tax treatment in the near term. But the tax status of municipal bonds is far from resolved in Congress.

Credit Quality

With all the fiscal negotiation drama in Washington, interest in municipal securities has been particularly high in the last few months. We’ve talked a lot about munis on the blog including an ongoing call that they are attractive compared with Treasury securities, particularly for taxable investors looking for income.

Last week, Matt Tucker helped explain how investors can determine if a muni or a corporate bond offers a higher yield after taxes.

But we continue to field inquiries from investors who want to go beyond comparing muni yields with Treasury yields or benchmark corporate yields. They contend that comparison misses the possibility that muni yields appear comparatively high because they may reflect a justifiable difference in their credit quality and default potential. In addition, the on-again off-again talk that the muni tax exemption itself may be at risk as part of fiscal negotiations in Washington adds to the