Municipal Resets

• Product Overview
• Features and Benefits
• Risks and Considerations
• Availability Through Fidelity
• Underlying Credit Ratings

Product Overview

Municipal resets belong to a class of bonds known as Auction Rate Securities whose coupon rates are periodically reset through auctions generally held every 1, 7, 14, 28 and 35 days. Some bonds even reset daily although in these cases interest is paid out monthly with accrued interest.

Although the rates are reset frequently through an auction process, the underlying municipal bond may be issued with a maturity lasting anywhere from 5 to 30 years. Municipal resets were introduced primarily as an institutional product and over time more retail investors have begun to participate in the auction process.

Investors should pay close attention to the minimum required investment which is typically $25,000.

Remember that the stated interest rate is quoted on an annualized basis; but it will only apply until the next reset date when it is likely that a different rate will be set. The coupon amounts paid will reflect the number of days that passed under a particular rate.

The Municipal Reset Auction Process

Municipal resets are sold through a Dutch Auction, which is a competitive bidding process used to determine rates on each auction date. Bids from all participants are submitted to the auction agent, typically the primary underwriter of the offering. The winning bid rate is the lowest possible interest rate bid that balances the cumulative total of securities demanded (buyers) to the amount auctioned (sellers).

All the accepted bids receive the same rate of interest as the lowest bid that sells the entire offering. This is known as the Clearing Rate.

Municipal Reset Dutch Auction Example
Offering size is 100MM

Buying

• As a buyer of a municipal reset you need to submit your bids at a specified rate on the day of the auction. It is not possible to submit market orders.
• You will be notified during the day if you were successful at the auction. The new rate typically becomes effective on the following business day – or on the same day in the case of issues that reset daily.

Holding

• Simply by doing nothing you will continue to hold an existing position and the coupon rate you receive will be reset automatically at the next auction.

Selling

Owners of a municipal reset may:

• Sell with a Limit Coupon/Hold at a Limit Coupon: Here you would specify the rate at which you are willing to continue holding the municipal reset. This order is subject to the Auction outcome, so if the auction clears at a rate equal to or above the rate you stipulated you will keep your bonds – and they will pay at the rate the auction clears at. If the auction result sets a rate below your limit coupon, then your bonds will be sold.
• Sell: Specify the quantity you wish to sell at the next auction date at the clearing rate.

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Benefits of Municipal Resets

• A municipal reset is a product whose coupon automatically regularly adjusts in keeping with the increases and decreases of short–term market interest rates. Municipal resets provide for a frequent stream of coupon payments
• As with other municipal bonds, the interest income is expected to be exempt from federal income taxes. It may also be exempt from state and local income taxes if you are a resident of the state of the issuer. Some municipal bonds generate interest that is also exempt from the federal alternative minimum tax (AMT). Short– and long–term capital gains and gains characterized as market discount are recognized when bonds are sold or mature are generally taxable at both the state and federal level.
• Municipal resets are issued at par and generally sell at par when selling via auction on the reset date. There are frequent and predictable windows to enter and exit a position when auctions are occurring normally.  However, at times of limited or no liquidity, auctions can and do fail resulting in an investor’s inability to sell for an indefinite period and potentially impacting a customer's ability to sell at par.

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Risks and Considerations

• Default Risk: Although auction rate securities may have high credit ratings, there is a risk of issuer default.  As with other fixed income securities, payment is subject to the ability of the issuer to pay.
• Failed auctions: Can occur when the auction agent does not receive sufficient bids below the fail rate – a situation often exacerbated by volatility or uncertainty in the credit markets.  At times of limited or no liquidity, however, auctions can fail and have failed resulting in an investor’s inability to sell for an indefinite period.  When an auction fails, the rate is set at the fail rate established in the prospectus. The fail rate is often a multiple of a reference rate such as the London Interbank Offered Rate (LIBOR) or an index of Treasury securities.
  
  A failed auction doesn’t constitute a default. The reset payment will continue to be paid and will be adjusted to the fail rate in the event of a failed auction. The responsibility for payment lies with the issuer and in the case of insured bonds, with the issuer and/or the insurer.  Insured bonds contain credit ratings for both the issuer and the insurer.  These ratings may vary.  In some circumstances, the issuer’s rating may be higher.  In other circumstances, the insurer’s rating may be higher.  Carefully consider both ratings when evaluating an insured bond for possible purchase.
  
  Owners of bonds who are unable to liquidate in a failed auction will continue to own the municipal reset at the set fail rate until the date of the next auction. In the event of continued failed auctions, two scenarios are likely:
  
  
  1. The issuer may decide to fully or partially call or redeem the bonds. When Fidelity holds securities in street or bearer form on behalf of the customer and such securities are callable in part, Fidelity utilizes an impartial lottery allocation system (subject to applicable rules) to determine the securities that will be selected for redemption.
  2. The issuer does not call the bonds and continues to pay the fail rate. In this scenario, the owner continues to receive payments at the fail rate established in the prospectus. Please bear in mind that in some instances the fail rate may be reset to zero, meaning that the security will not pay interest at least until the next auction date.
     
     It is very important for owners of auction rate securities who want to sell and whose securities do not clear their auctions to continue to submit sell orders at each regularly scheduled auction until the securities are sold. This is particularly important because some failed auctions may partially clear — meaning that some of the securities offered in that failed auction do, in fact, sell on that date. In auctions that partially clear, customers entering sell orders may find their orders partially filled, completely filled or not filled at all. Unless such orders are submitted, customers will continue to own these bonds even if there is an auction that partially clears or subsequent auctions for those bonds are successful.
• If the owner wishes to sell at any time during the life of a municipal reset that continues to fail, it is incumbent upon the owner to submit a sell order at each regularly scheduled auction until the security is sold. Without submitting this order, a customer will continue to own the bond even if subsequent auctions for that bond are successful.
• Tax Considerations: Tax–exempt interest generated by municipal bonds is usually more beneficial the higher your tax bracket so municipal bonds may not be appropriate for investors in all tax brackets. If you are subject to the federal alternative minimum tax (AMT), the interest income generated by certain municipal bonds (mainly private activity bonds) is subject to it. You may set your search criteria to exclude municipal bonds subject to the AMT. Municipal bonds are usually not appropriate holdings for tax–advantaged accounts such as IRAs and other retirement accounts. Please consult with your tax advisor for advice about your specific situation.
• Inflation Risk: The risk that the rate of the yield to call or maturity of the investment may not provide a positive return over the rate of inflation for the period of the investment.
• Limited Trading Hours: Orders must be placed from 8am – 11am ET on the day of reset. With bonds that reset daily, the time is reduced to between 8am – 10am ET. Orders cannot be accepted before these times and if sent will not be considered for the auction.

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Availability through Fidelity

• Fidelity offers numerous municipal resets from most states.
• Check that the "Trade" link is active. This means that a particular offering is available for auction on this day. See current offerings.
• When evaluating a municipal reset for possible purchase, make use of "current rate" and "next anticipated rate". These two data elements provide indications of the possible yield range of an upcoming auction. These data points are provided by those firms that support the Dutch auction and are intended to provide general guidance about the issuer’s rates under current market conditions. This information can be accessed at: www.fidelity.com/muniresets.
• Note that Buy orders may be placed online on Fidelity.com for municipal resets on the day of the auction. Sell or Hold Orders may also be placed with a Fidelity Fixed Income Specialist (800–544–5372) up to five business days in advance of the auction.

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Underlying Credit Ratings

Due to the fact that the majority of municipal resets are insured, customers may be interested to know the underlying credit rating (PDF) , if available. Please note that the underlying credit ratings shown here are current only as of the date shown, and are not updated in real–time. The current ratings may have changed, and may be higher or lower.  For current ratings information on a specific issue, please call Fidelity at 800-544-5372. Top