General Obligation Bond (GO)

A General Obligation Bond (GO bond) is a common type of municipal bond that is secured by the issuing government’s pledge to use legally available resources, including tax revenues, to repay bondholders. Unlike revenue bonds, which are repaid using revenue generated from a specific project or source, GO bonds are backed by the full faith and credit of the issuing municipality.

Key Features

Full Faith and Credit

GO bonds are secured by the “full faith and credit” of the issuing municipality. This means that the government pledges its entire resources to repay the bond, which can include imposing new taxes and reallocating budgetary priorities.

Tax Backing

The primary source of funds for repaying GO bonds is tax revenue. These can be property taxes, sales taxes, or other general fund revenues. Because the source is typically more stable and predictable, GO bonds are considered lower risk compared to revenue bonds.

Voter Approval

Issuance of GO bonds usually requires voter approval through a referendum. This process involves putting the bond issue to a vote during a designated election, and a majority of voters must consent to the bond issuance.

Use of Funds

GO bonds are often used to fund public projects such as infrastructure improvements, schools, and emergency services. Because these projects are generally seen as beneficial to the community as a whole, they are more likely to gain voter approval.

Advantages

Lower Risk

Because they are backed by the taxing authority and full credit of the issuer, GO bonds generally have lower risk of default compared to other types of municipal bonds. This makes them attractive to conservative investors.

Tax-Exemptions

Interest earned on GO bonds is often exempt from federal income tax and, in many cases, from state and local taxes as well. This tax advantage can make GO bonds particularly attractive to investors in higher tax brackets.

Predictable Payments

The revenue backing for GO bonds tends to be more stable and predictable, often leading to more reliable and timely interest and principal payments to bondholders.

Disadvantages

Political Risk

Since voter approval is required for issuance, there is a certain level of political risk involved. A proposed GO bond can be rejected by voters, delaying funding for necessary projects.

Tax Burden

Repaying GO bonds may require raising taxes, which can be unpopular with residents. Increased taxes can also potentially slow economic growth, thereby reducing overall tax revenues.

Credit Rating

The credit rating of the issuing municipality can significantly impact the interest rates on GO bonds. A lower credit rating may lead to higher interest rates, increasing the cost of borrowing for the issuer.

Types of General Obligation Bonds

Limited-Tax General Obligation Bonds

These are GO bonds that have a cap on the tax rate that can be levied to repay the bond. This cap provides a ceiling on the amount of tax revenue that can be used, which can limit the security of the bond.

Unlimited-Tax General Obligation Bonds

These GO bonds have no cap on the tax rate that can be levied to repay them. They provide a higher level of security for bondholders because the issuer can raise taxes as much as needed to meet its debt obligations.

Issuance Process

Pre-Issuance

1. Needs Assessment: The municipality identifies the need for funding, often through a needs assessment or feasibility study.
2. Legislative Approval: The proposed bond issue is reviewed and approved by the governing body (e.g., city council or board of supervisors).
3. Voter Approval: The bond proposal is placed on the ballot for voter approval during an election.

Issuance

1. Structuring the Bond: Details such as the amount, maturity, coupon rates, and repayment schedule are determined.
2. Credit Rating: The issuing municipality seeks a credit rating from one or more of the major rating agencies.
3. Bond Sale: The bonds are sold in either a competitive or negotiated sale. In a competitive sale, multiple underwriters bid for the bonds, whereas in a negotiated sale, the issuer selects an underwriter ahead of time.

Post-Issuance

1. Fund Allocation: The proceeds from the bond sale are allocated for the intended projects.
2. Debt Service: The municipality makes regular interest payments to bondholders and repays the principal at maturity.
3. Ongoing Compliance: The issuer must comply with any covenants and regulatory requirements, including maintaining sufficient tax revenues and financial transparency.

Risk Factors

Economic Conditions

Economic downturns can affect the revenue-generating capacity of the issuing municipality, making it harder to repay GO bonds.

Legislative Changes

Changes in laws governing tax rates and spending priorities could impact the ability to repay GO bonds.

Demographic Changes

Population shifts can alter the tax base, affecting the revenue available to meet bond obligations.

Natural Disasters

Unexpected events like natural disasters can strain municipal finances, diverting resources from debt repayment to emergency spending.

Key Players in the GO Bond Market

Issuers

Typical issuers of GO bonds include states, cities, counties, and school districts. These entities issue bonds to finance a wide range of public projects that benefit the community.

Underwriters

Investment banks such as Goldman Sachs and JPMorgan Chase play significant roles as underwriters, helping municipalities structure and sell their bonds.

Credit Rating Agencies

Agencies like Moody’s, Standard & Poor’s, and Fitch rate GO bonds based on the creditworthiness of the issuer. Higher ratings generally translate into lower interest rates.

Conclusion

General Obligation Bonds are a critical tool for municipalities to finance public projects. Their low-risk profile and tax advantages make them attractive to investors, while their reliance on tax revenues and voter approval ensures accountability and public support. Understanding the intricacies of GO bonds, from issuance to repayment, is essential for both issuers and investors in the municipal bond market.