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Duration: 3:20

Contributor: Interactive Brokers

Level: Beginner

Interactive Brokers’ senior market analyst Steven Levine provides some insights into general obligation bonds (GOs), including what differentiates these securities from other municipal debt offerings such as revenue bonds, as well as methods of analyses. This lesson is part of a video series on the U.S. Municipal Bond Market – available at IBKR Traders’ Academy.

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Study Notes:

General Obligation (GO) bonds are typical, general purpose bonds issued by a municipality, generally to help finance a capital project like a railway or a road. This is similar to a corporation, which may use proceeds from a debt sale for general corporate purposes.

Only issuers that can charge and collect taxes, such as state and local governments, may issue GOs, since they are backed in large part by that issuer’s taxing power.

 

For example:

State GOs may be secured by a variety of funding sources such as tax receipts from:

  • Income,
  • Sales, and
  • Gas

Local issuers, such as counties and cities, usually derive their revenue from taxes on:

  • Property, and
  • Schools

Pre-issuance Approvals

First, the proposed issuance would require voter approval given it would be the taxpayers’ money that would be used for servicing the debt. Also, the state’s own statutory and constitutional powers may place a cap on how much debt the issuer may accumulate – this is commonly known as a debt ceiling.

Conducting Analysis

Before investing in a GO, a bond investor may want to analyze several factors about the issuer such as:

  • The health of its economy
  • Its overall character, namely the industries or companies operating within its borders
  • Its employment rate and the average income of its residents
  • Changes in its population levels
  • Its overall financial condition, including its existing debt burden
  • The amount of its unfunded pension liabilities, and how it generally handles its fiscal responsibilities

For example:

 

When considering an investment in the New York City GO, an investor may want to consider:

  • How the city’s employment base has been trending lower over the past few years,
  • How its largest source of revenues is from property taxes, while its real estate market has been sluggish recently.

Meanwhile, other major sources of New York City revenue include:

  • Sales,
  • Income taxes, and
  • Intergovernmental revenues such as
    • Grants, and
    • Shared taxes

Furthermore, while the U.S. census-estimated population for New York City in 2018 had risen over the past eight years – it is still only about half the rate of national population growth.

Defaults

Like other issuers, a municipality is subject to default on its debt obligations, and bond investors generally look for any potential red flags to mitigate this worst-case scenario.

Some of the biggest municipal defaults of the past decade include:

  • Puerto Rico,
  • Detroit, and
  • Jefferson County, Alabama

In 1975, New York City had also faced a bankruptcy, and a municipal bond analyst may look back at that time and assess how times have changed, and how they may be similar.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Supporting documentation for any claims and statistical information will be provided upon request.

Any stock, options or futures symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

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