General Obligation Bonds

What backs a GO

A general obligation bond is backed by the full faith, credit and taxing power of the issuing municipality. There is no specific project revenue standing behind it; the security is the issuer's ability and legal obligation to raise taxes to pay.

Which tax depends on the issuer. Cities, counties, school districts and other local issuers rely primarily on ad valorem property taxes — taxes levied according to assessed value. States do not generally levy property taxes, so a state GO is backed by income taxes, sales taxes, excise taxes and licence fees. That distinction is a standing exam question: if the issuer is a state, do not answer property taxes.

Property tax mechanics appear in questions. Assessed valuation is the taxable value assigned to property, which is typically a stated percentage of market value. The rate is expressed in mills, where one mill is one-tenth of one cent, or $1 of tax per $1,000 of assessed value. A property assessed at $200,000 in a district levying 12 mills owes $2,400.

Because a GO is a claim on general tax revenue, it competes with every other call on the budget — schools, police, pensions. Its credit therefore depends on the health of the whole entity rather than on one project, which is why GO analysis is essentially an analysis of the issuer's economy and finances.

Debt limits, voter approval and limited tax GOs

Because taxing power is finite and politically constrained, most states impose a statutory or constitutional debt limit on local issuers, expressed as a percentage of assessed valuation. A municipality at its limit cannot issue more GO debt without changing the law.

Debt above the limit, or new GO debt generally, usually requires voter approval through a bond referendum. This is a structural difference from revenue bonds, which generally do not, and it is one of the cleanest comparison questions on the exam: GO bonds typically require voter approval; revenue bonds typically do not.

A limited tax general obligation bond is a GO whose supporting tax is capped — the issuer promises to levy for debt service only up to a stated rate or amount. It sits between an ordinary GO and a revenue bond in security, and it yields more than an unlimited tax GO of the same issuer for exactly that reason.

A double-barrelled bond is backed both by a specific revenue source and by the issuer's general taxing power. It is classified and analysed as a GO, because the taxing power is the stronger of the two claims. If a question describes a bond secured by water system revenues and additionally by the city's full faith and credit, the answer is that it is a double-barrelled bond and it is a GO.

The analytical ratios

Municipal credit analysis for GO bonds runs on a small set of ratios, and the exam expects you to know what each one measures and which direction is favourable.

Net debt per capita. Net direct debt divided by population. It measures the burden on each resident. Lower is better, and the figure is meaningful only compared with similar issuers.

Net debt to assessed valuation. Net direct debt divided by the assessed value of taxable property. It measures debt against the tax base that must service it. Lower is better. Some analysts use market valuation instead, which produces a smaller and less comparable number.

Net debt to estimated full valuation. The same idea using estimated market value rather than assessed value.

Tax collection ratio. Taxes actually collected divided by taxes levied. A ratio well below one signals distress in the tax base — the issuer's legal right to the money is not the same as receiving it.

Debt trend. Whether the ratios are rising or falling over several years matters more than any single value.

Beyond the ratios, an analyst looks at the diversity and stability of the local economy, the largest taxpayers and how concentrated the base is on them, population trends, unfunded pension and other post-employment benefit obligations, and the issuer's budget practices and reserves. A single dominant employer is a genuine credit risk: if it leaves, the tax base leaves with it.

Overlapping debt

A property owner in a city usually sits inside several taxing jurisdictions at once — the city, the county, the school district, perhaps a water district. Each may have issued its own GO debt, and all of it is ultimately serviced by taxes on the same properties.

Overlapping debt, also called coterminous debt, is the share of another jurisdiction's debt attributable to the property within the issuer under analysis. It is apportioned by relative assessed valuation: if a city contains 40 percent of the county's assessed value, 40 percent of the county's debt is overlapping debt of the city.

Direct debt is what the issuer itself has borrowed. Total or overall net debt is direct debt plus overlapping debt, and it is the figure that reflects the real burden on a taxpayer in the city, because that taxpayer pays for all of it.

The exam's version: an analyst evaluating a city GO must include overlapping debt, and a candidate who computes debt per capita using direct debt alone has understated the burden. Note that revenue bonds of an overlapping jurisdiction are generally excluded from the calculation, because they are serviced by project revenue rather than by the shared tax base — which is exactly the point of the next lesson.