Municipal Bonds and Notes that are backed by the taxing power of a municipality are General Obligation bonds. These debt obligations can be state or local issued. Each of these municipalities can use the taxes at their disposal and authorization to raise the money needed to pay off the bond interest and the principal.
While almost all Muni bonds are considered very safe as it relates to timely payments of Interest and return of principal at maturity, G.O Bonds are considered stronger/safer than revenue bonds - assuming all other factors being equal (maturity, issuer etc). Revenue bonds are backed by a revenue generating facility like a bridge, tolls, usage rentals and other money producing projects. While these are generally safe as well, bonds backed by taxes will have more certainty in the money backing the bond issue.
Death and Taxes are the 2 sure things. If a bond is backed by the taxing power of the state, town or other municipal entity, it is assumed those taxes will be collected. If there is an anticipated lateness in tax collection, the municipality may issue short term notes for immediate financing. Those will most likely be Tax Anticipation Notes - or TAN's for short.
General Obligation Bonds are backed by a variety of taxes
Local issues will primarily use Property Taxes to back bonds used for School needs, local roads or anything that is non revenue producing at the local level.
The Series 7 Exam has more municipal issue questions than all of the other types of bonds. The MSRB - Municipal Securities Rule Making Board will make up a good amount of questions surrounding the new issue process and the regulations concerning the underwritings. This will be discussed in further posts. But as always, please feel free to ask a question on this blog on any FINRA Series Exam topic you need help in.
Non local or State Issued General Obligation Bonds
If the state of Ohio is doing a bond issue, they will use non-property taxes as their primary resource for dollars. States will normally use other taxes such As: Income, Sales and other non local taxes.
Since a municipality relies on the taxes it can raise, the town must have a healthy tax base at their disposal - or at least healthy enough to support the bond and garner a good rating.
A rating company will examine the following before issuing a credit score on the bond:
- Debt per capita
- Income per capita
- Property values or assessed valuations
- Population Growth
Other Definitions for the Series 7:
Overlapping Debt - When a local tax base overlaps the tax base of another, it is known as overlapping debt. An example of this could be two towns sharing the resources of a school, where both areas are paying taxes to support the same facility or services.
Ad Valorem Tax - The name of the property tax that residential and commercial residents are taxed at is called the Ad Valorem Tax.
Competitive underwriting - All General Obligation bonds must be underwritten on a competitive basis. This means that the issuer must offer a competitive bidding process open to broker dealers, where the best price (lowest interest cost) wins. Revenue bonds can be underwritten through negotiation of select Broker Dealers that the municipality may have relationships with. This difference should make common sense, since in a G.O Bond you are raising EVERYONE'S Taxes in the effected area to back the issue - it is very important that the absolute lowest interest rate possible is achieved - thus competitive underwriting ensures that.
Series 7 Study Tip Help: When asked about the difference between GO and Revenue Bonds, remember - "Obligation" means through taxes. It is the obligation/responsibility of the Government entity to raise the needed tax dollars to back a G.O. Bond. A revenue bond cannot carry such as obligation since revenue from a place or project can never be exact.
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Hope this helps!
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