When a town or other municipality wishes to issue a Municipal Bond that is backed or secured by taxes, it is a General Obligation issue.
GO Bonds can be issued by states, towns, cities, counties, school districts or other municipal authorities.
Towns and other local issues:
Local areas will normally secure their bonds using property taxes. A school district bond could be underwritten with a broker dealer and the property tax increase within the town paying for the school would back the bond.
The property tax is called the "Ad Valorem Tax". Taxes are computed based on Millage Rates. The higher the mills, the higher the tax rate. Areas that have high income and property values will produce the greatest amount of property tax revenue.
State and non-local Municipal Bonds:
Income, sales, and other taxes are used to back state issues. Property taxes are not used. Other taxes such as Gas, Cigarette and other assessments can be used as well.
How a General Obligation Bond is issued to the market:
Since a General Obligation (GO) Bond uses tax dollars to secure it, certain restrictions apply to the issuer. The main restriction is that the issuer (Town, City, etc.) must bring the offering to broker dealers on a competitive basis. This means that the issuer cannot pick and choose broker dealers or underwriters to offer the bond. "Revenue municipal bonds", which are NOT backed by taxes, do not have to be brought to market this way. Revenue bonds can be "negotiated". This means that the issuer can negotiate with one or a few dealers on the offering.
The true difference is that General Obligation Bonds are backed by taxes. You are using tax money. The people who live in your town are paying for this school issue or other bond. You must prove that you are paying the lowest possible rate on the bond, or your tax payers and residents will NOT be happy. Revenue bonds are backed by revenues generated from something. A toll bridge or parking facility are good examples of revenue bond income sources. Since tax dollars are not used, rules permit revenue bond issues to negotiate.
A General Obligation offering must be put out using a bidding process. The lowest total interest cost to the issue will win the bonds.
If broker dealer "A" offers 6.25% for a five year bond bid and broker dealer "B" offers 6.10%, then dealer "B" will be the winning bidder. The interest rate is what the town or city must pay, so the lower the better.
The general obligation bond will be offered in either one maturity or several. An example of a Municipal bond offering could be:
Rate Maturity
6.00% 1-15-2009
6.15% 1-15-2012
6.25% 1-15-2015
In this case, the issuer is offering 3 maturities - with the longer term bonds offering a higher coupon rate. These are called serial bonds. Serial issues have multiple maturity dates. Term bonds are bonds that offer one maturity. Serial and term bonds can be general obligation bonds.
All things being equal, GO bonds are normally rated higher and considered safer. The tax base is a concrete money source that is there to protect the bond throughout it's life.
Municipal bonds should be owned by most investors. Their interest is federally tax free and the credit quality is usually excellent.
Learn more about Municipals Here
Nick Hunter is the President of American Investment Training, AIT. He also writes for Brokerjobs.com - a career and financial website.
