A little more than a year after the first signs of mayhem in the municipal bond markets, issuers are still defaulting, and investors are still worried. And while investing professionals would say that in this climate, it s best to leave your bond research to the experts, that s not the only way: A little diligence, a free afternoon and an Internet connection is enough to start separating the risky munis from the stable ones.

The goal to build a portfolio of municipal bonds that reduces risk and supplies steady tax-exempt income is still possible, says financial advisor Dennis Gibb, president of Sweetwater Investments, an investment advisory firm in Redmond, Wash. By picking issuers whose finances and politics you can track thoroughly, like your local or state government, and investing in bonds backed by recession-proof, essential services, it s possible to avoid potential blow-ups and ride out the current muni mess. It s far from easy, says Matt Fabian, research director of Municipal Market Advisors, but in some cases you can figure things out.

Of course, doing due diligence on a bond issue isn t the most entertaining way to spend a Saturday afternoon. Issuing documents are often hundreds of pages long, written in dense legalese. Bond issuers are slow to disclose bad news, and with about 1.5 million separate bonds out there, it s a highly fragmented market, says Marilyn Cohen, head of Envision Capital, a Los Angeles fixed income investment firm. That s why most people rely on their broker, or simply buy a muni bond fund. Still, not every broker is a muni expert and may not have access to bonds that meet your needs. Doing your own research is time consuming, says Gibb, but it gets easier with practice.

Before looking for new bonds, take an inventory of your current portfolio to see if your bonds and their issuers are as good as they were when you bought them. Many issues have lost the safeguard of municipal bond insurance, which backed high-quality ratings for about half of top-rated bonds before the 2008 crash, says George Rusnak, managing director at Wells Fargo Wealth Management. Now, he says, only about 7% of top-rated munis are insured at a time when state and local governments are increasingly strapped for cash. Quite frankly, we re seeing a lot of people who don t understand the credit problems they have in their portfolios, Rusnak says. Be prepared to hang on to bonds that have lost value and simply cash out at maturity, he says.

Once you know what you ve got, look at gaps in when your bonds mature. The goal is a ladder of bonds that are constantly maturing, with about a seven-year spread at minimum, Gibb suggests. Bear these fundamental ideas in mind when you go shopping:

Buy what you know or can learn

Purchase general obligation and essential services bonds for utilities and sewage service in areas where you have a solid understanding of economic conditions. People are not doing away with their water or their electric bills, even if they re not paying their mortgage, says Gibb. And only 1% of munis in payment default come from such essential sectors, according to Municipal Market Advisors data.

Read the official disclosures

The Municipal Securities Rulemaking Board s Electronic Municipal Market Access site, called EMMA, lets you check a bond s original issuing statement, which explains its purpose and proposed source of repayment. The site also has price and yield data, trading history and important required disclosures. Check annual financial reports and other material information: Notices of late payments, draws on financial reserves, ratings downgrades and any changes to bondholders rights are typically cause for concern.

but don t stop there

The official disclosures have about a six-month lag, says Merritt chief executive Richard Ciccarone, so local media near the bond issuer may offer a more current perspective. Bookmark the web sites of newspapers that cover the areas in which your bonds were issued, or set up a Google News alert to help you stay on top of reports on regional unemployment rates and city and state budget woes. Bond analysts also check state fiscal watch lists for financially troubled cities, says Fabian.

Look for uncommon indicators

Less straightforward measures can help bondholders understand the ultimate health of a community. Gibb likes to use U-Haul rate comparisons as a barometer of local markets: If rates for a one-way move from Detroit to, say, Atlanta, are much higher than the other way around, it s because Detroit is losing residents and not getting new arrivals, he says. And that affects property taxes, sales taxes and income taxes, the lifeblood of the steadiest municipal bonds. Similarly, a local mall closure, for example, will directly affect a sales-tax-backed bond, says Fabian.

Avoid high-yield one-offs

Bonds that support stadiums, cable fiber optic systems and new housing developments can be attractive because they often pay higher yields, but they depend on revenue that is particularly vulnerable to continued economic trouble, says Cohen of Envision Capital. Data from Municipal Market Advisors show that 94% of municipal bonds now in default are related to housing developments, stadiums, cable fiber optic systems, toll roads and other special projects whose financing collapsed in the economic crisis.

Municipal bond research fundamentally, the decision whether to lend money to a local government is based on common sense analysis of available public data, taken to a nearly obsessive degree, professionals say. There s no surefire way to know when a state or local government might default or on which issues, but every state or local entity that issues a bond is required to file an issuing statement that explains how a bond gets paid back, plus annual financial reports and any notices of events that affect its credit quality. Governments and their budgets are also often covered by local media, which can offer some inkling of the financial tides. And even data from unlikely sources can be useful, which is why experts recommend buying muni bonds close to home, so it s easier to keep track. The key is figuring out your bond issuers financial facts and knowing what s truly relevant to your investments.

Next: 5 Risky Issues to Avoid

5 Risky Issues to Avoid

We found five bonds showing a variety of warning signs investors should consider. Even though defaults aren t a certainty, these are good examples of how once-safe munis have hit rough patches:

Asian Art Museum, San Francisco

Home to one of the West s biggest Asian art collections, the museum borrowed $120 million with variable rate tax-exempt bonds in 2005. Its bond insurer MBIA lost its AAA rating in 2008, and JPMorgan Chase stepped in with a letter of credit that backed the bonds, but it expires Dec. 21. If that happens, the bank would call the bonds and investors would get back the face value of their bonds and the accrued interest. However, they would lose the income payments on the issues, which don t expire until 2034, but last traded this month at 0.35%. Museum chief financial officer Mark McLoughlin says negations with the bank and insurer remain a work in process.

Electric Light & Power, Crawfordsville, Ind.

The utility s Accelplus telecommunications unit took on $16.6 million in muni debt in 2006 at 5% to build a fiber optic cable television system. The recession and job losses drove customers from the area, and competition from Comcast means the utility can t cover its debt service, says Crawfordsville Electric Light & Power manager Phillip Goode. A regulatory filing on EMMA says it now intends to pay only the interest on the bond from its reserve fund in its Jan. 1 payment a good indicator the bond revenue stream is in trouble, says Fabian. Goode says the utility is considering selling the network, which could allow it to repay bondholders but end their source of tax-exempt income.

Citi Field, Queens, N.Y .

The New York City Industrial Development Agency issued $87 million in tax-free bonds with a 5% yield in 2006 to help finance the construction of Citi Field, the new home of the Mets. In February, Moody s and Standard & Poor s cut their ratings to junk status, and according to reports at the time, the Mets said it was exclusively a bond insurance issue. But the bond payments do depend on revenues from pricey premium seats and luxury boxes, as well food and parking sales, and investors can t help noticing shrinking crowds at Citi Field. In its 2009 inaugural season, attendance dropped 22% from the year before, then another 19% in 2010, according to Major League Baseball. The club, which did not return calls for comment, has lowered many regular ticket prices for next season.

Yankee Stadium, The Bronx, N.Y.

The same agency, which didn t return calls for comment, issued $237 million in tax-exempt industrial development bonds to enable Bronx Parking Development to build garages next to the new Yankee Stadium. The developer, which is independent of the team, reported in August it had taken in only $4.8 million in revenue, less than half of the $9.8 million required by its revenue projections, in part because of competition from a parking lot at a nearby mall. A consultant s report posted on EMMA proposed hiking the regular parking fee from $23 per game to as much as $47 as default risk increases. They re not necessarily on the precipice, but they re deteriorating, Cohen says.

H arris County Sports Authority, Houston

The authority issued bonds to finance stadiums for the Texans and the Astros and for an arena for the Rockets, and last month dipped into $5 million in reserve funds to pay its insurer, which had to buy back some bonds ahead of schedule. In August, Moody s dropped $115 million in bonds issued at 5.25% to junk status and warned of payment defaults by March 2011, and Standard & Poor s cut the rating to junk status in September. Investors should look out for further revenue declines like the one in the authority s 2009 annual report: Hotel and car rental taxes dropped $7.4 million from 2008, a 16% decline. Ratings agencies expect things to get worse, but Authority executive director Janis Schmees says bondholders will be paid off, even if the payments are late.