Analysis of General Obligation (GO) Bonds
Now that you understand portfolio diversification, let's look at how analysts evaluate the creditworthiness of individual GO bonds. Since GO bonds are backed by taxing power rather than project revenue, the analysis focuses on the issuer's overall financial health.
Characteristics of the Issuer
GO bonds are backed by the full faith and credit and taxing power of the issuing municipality. The issuer's overall financial health determines the bond's credit quality.
Key indicators analysts evaluate:
- Population trends - growing or declining?
- Employment diversity - is the economy dependent on a single employer or industry?
- Income levels - higher incomes support a stronger tax base
- Property values - assessed valuations directly affect the GO bond's backing
- Management quality - competent fiscal management signals lower risk
The Debt Structure: Net Direct Debt and Overlapping Debt
Understanding a municipality's debt structure is essential for GO bond analysis. There are several layers:
Net Direct Debt
- Total direct debt = all debt issued directly by the municipality
- Self-supporting debt = revenue bonds and other debts repaid from specific revenue sources (NOT from taxes)
- Net direct debt = total direct debt - self-supporting debt
Revenue bonds are excluded from net direct debt because they don't rely on the issuer's taxing power.
Overlapping Debt
- Overlapping debt = the municipality's proportional share of debt from other taxing authorities that overlap the same tax base
- Includes: counties, school districts, special districts, water authorities
- State debt is excluded from overlapping debt because states rely on income and sales taxes, not local property taxes
Net Overall Debt
Net overall debt = net direct debt + overlapping debt
This is the total debt burden supported by the local tax base.
Exam Tip: Gotchas
- Net direct debt EXCLUDES revenue bonds because they are self-supporting. The exam may present a municipality's total debt and ask you to calculate net direct debt by subtracting revenue bond debt.
- Overlapping debt includes school districts and counties but never includes state debt (states rely on income and sales taxes, not local property taxes).
Factors Affecting the Issuer's Ability to Pay
| Factor | What to Look For |
|---|---|
| Tax base | Assessed valuation of property, diversity of local economy, major employers |
| Tax collection rate | Percentage of taxes actually collected (higher is better) |
| Revenue sources | Property taxes, income taxes, sales taxes, intergovernmental transfers |
| Unfunded pension liabilities | Growing obligations that compete with debt service payments |
| Legal debt limits | State-imposed ceilings on GO debt (expressed as a % of assessed property value) |
Municipal Debt Ratios
Analysts use four key ratios to evaluate a GO bond issuer's credit quality:
| Ratio | Formula | What It Measures |
|---|---|---|
| Net debt to assessed valuation | Net overall debt / assessed value of taxable property | Debt burden relative to the tax base |
| Net debt per capita | Net overall debt / population | Debt burden per resident |
| Debt service to total budget | Annual debt service / annual operating budget | How much of the budget goes to debt payments |
| Tax collection ratio | Taxes collected / taxes levied | Ability to collect what is owed |
Key relationship: A declining assessed valuation or population increases the per-capita and per-dollar debt ratios, signaling deteriorating credit quality.
- Analysts compare these ratios to peer municipalities and national medians
- Worsening ratios suggest the tax base is shrinking relative to the debt load
Think of it this way: If people leave a town (population drops) but the town's debt stays the same, each remaining resident is now responsible for a bigger share of that debt. The same logic applies if property values fall: the same debt is now backed by a smaller tax base.
Exam Tip: Gotchas
- Declining population or property values make debt ratios worse, not better, because the same debt is spread across a shrinking base.
- A high tax collection ratio (close to 100%) is a positive credit indicator. A low ratio signals collection problems.