General Obligation (GO) Bonds
Now that you understand the general features of municipal securities, let's examine the first major category: general obligation bonds, which are backed by the issuer's taxing power rather than a specific revenue source.
Characteristics of GO Bond Issuers
- Backed by the full faith and credit and taxing power of the issuing municipality
- The issuer pledges its ability to levy ad valorem (property) taxes to pay debt service
- Typically issued by entities with taxing authority: states, cities, counties, school districts, towns
- GO bonds usually require voter approval (referendum) before issuance
- Used to fund projects that benefit the entire community but do not generate revenue (parks, schools, police stations, government buildings)
Exam Tip: Gotchas
- GO bonds require voter approval; revenue bonds do not. This is one of the most frequently tested distinctions between the two types of municipal bonds.
Unlimited Tax vs. Limited Tax GO Bonds
| Type | Taxing Power | Risk Level |
|---|---|---|
| Unlimited tax GO bonds | Issuer can levy taxes at whatever rate is necessary to pay debt service (no cap) | Lower risk |
| Limited tax GO bonds | Issuer's taxing power is capped at a specified rate | Higher risk |
- If tax revenue at the capped rate is insufficient for a limited tax GO, the issuer cannot raise rates further
- Limited tax GOs carry more risk than unlimited tax GOs because of this constraint
Exam Tip: Gotchas
- "Unlimited" refers to taxing power, not borrowing. There is no cap on how high the tax rate can go to pay bondholders. "Limited" means the rate is capped.
- The exam may present a scenario where a limited tax GO issuer cannot meet debt service because it has hit its tax ceiling.
Factors Affecting the Issuer's Ability to Pay
When analyzing a GO bond's credit quality, look at these factors:
- Tax base: Size and diversity of the property tax base (assessed valuation of property)
- Population trends: Growing populations support a broader tax base
- Economic diversity: Reliance on a single industry increases risk
- Per capita income: Higher income means more capacity to absorb tax increases
- Unfunded pension obligations: Large pension liabilities strain budgets
- Overlapping debt: Debt from multiple issuers sharing the same tax base (e.g., city + county + school district all taxing the same property owners)
- Collection rate: Percentage of taxes actually collected vs. levied
- Fund balance/reserves: Healthy reserves indicate fiscal discipline
Exam Tip: Gotchas
- Overlapping debt is a GO bond concern, not a revenue bond concern. Multiple entities (city, county, school district) can tax the same property owners, stretching the shared tax base.
- A declining population weakens credit quality in two ways: it shrinks the tax base AND increases per capita debt burden on remaining residents.
Municipal Debt Ratios
These ratios help analysts compare GO bond issuers:
| Ratio | Formula | What It Measures |
|---|---|---|
| Net debt to assessed valuation | Net debt / Assessed value of property | Debt burden relative to the tax base |
| Net debt per capita | Net debt / Population | Debt burden per resident |
| Debt service to total budget | Annual debt service / Total budget | Portion of budget consumed by debt |
| Tax collection rate | Taxes collected / Taxes levied | Effectiveness of tax collection |
Calculating net debt:
- Net debt = Total debt minus self-supporting debt (revenue bonds paid from user fees, not taxes)
Think of it this way: If a city has $100 million in total debt but $30 million of that is water utility revenue bonds (paid by water customers, not taxpayers), the net debt is only $70 million. Analysts care about net debt because that is the portion taxpayers are on the hook for.
Exam Tip: Gotchas
- Self-supporting debt is excluded from net debt. Revenue bonds (like water/sewer) are paid from user fees, not taxes. If the exam gives you total debt, subtract any revenue bonds to get net debt.
- Net debt per capita rises even if total debt stays flat when population declines. A shrinking city means fewer taxpayers sharing the same debt load.