When venturing into the world of municipal bond investment, buyers are presented with a rich array of options to explore. One of the initial decisions to ponder is whether to invest in a General Obligation (GO) or a Revenue (Rev) bond.
A GO is a bond backed by the taxing power of the municipality, “full faith and credit”, like what the US government would have to do to pay back bonds…find tax dollars or raise the taxes. Although a GO has taxing power, some municipalities have unlimited taxing powers (UT), and some have limited taxing ability (LT). Types of GOs would include school bonds, roads, and some water or flood control districts to name a few.
A Rev is a bond backed by the revenue source of the project. For example, in a new development, a water and sewer system is necessary and is built to accommodate the homes in a defined area. A bond for this purpose, backed by the water and sewer revenues, collects fees from the homeowners and businesses in the area. In the case of a water and sewer Rev, this is an essential service, so all homes and businesses must have this capability; therefore, water and sewer systems are a reliable source of funds. Some types of revenue bonds include projects such as toll bridges, highways, stadiums, electricity providers, airports, and housing projects, to name a few. With the variety of revenue bonds, it is crutial to understand the details of the soursce of revenue. Right now, there are financial stresses on hospitals and universities because of changes in government funding. These are the issues affecting bond sectors and some specific projects more than others.
One ubiquitous question investors ask is, Which one is better to buy? The answer would seem almost obvious, the GO, but there are further points to consider in the ability to pay for both types. Let’s break it down.
Just because the taxing power of a municipality backs a bond does not make the ability to pay automatic. Let’s start with the ability to raise taxes and the difference between an LT and a UT.
The key difference between these two types of GOs lies in the extent of taxing power used to repay the bonds. An LT GO is bound by law to a statutory or legally preset limit on the debt. However, LT GO is not solely reliant on property taxes for repayment; it can tap into other revenue sources if necessary.
In addition, LT GOs do not necessarily need voter approval to come to market since they can use property and other revenue sources already in the budget to pay for bonds.
In contrast, UT GO bonds allow the issuer to raise taxes to service the debt without any cap. UT bonds usually require voter approval. When bond issues go on the ballot, they have the specific purpose and the expected cost and tax consequences for voters’ decision-making. If approved, the project then has the support of the given population and the language on how to repay the loan. In addition, these funds are earmarked for the project and cannot be used for other obligations of the issuer. Because of this feature, this would be a more secure option when choosing between the two types of GOs.
In conclusion, the choice between investing in General Obligation (GO) bonds and Revenue (Rev) bonds hinges on a careful evaluation of the underlying security and funding mechanisms. While GO bonds may initially seem more appealing due to their taxing power, the nuances of unlimited and limited taxing abilities can significantly impact their reliability. Unlimited taxing GOs, with their potential for voter approval and dedicated funding, offer a sense of security that may prove advantageous for investors seeking stability. Conversely, Rev bonds, backed by essential services, can also present reliable revenue streams, particularly in projects with consistent demand. Ultimately, understanding the financial health and revenue-generating capabilities of the municipality is crucial in making an informed decision that aligns with your investment goals.
Investing in municipal bonds can be complex, understanding the numerous differences, such as these, can be critical. Municipal bond investing is a complex field, especially for inexperienced investors. The intricacies of bond insurance, principal repayment sources, and bond calls can be cumbersome If these topics are unfamiliar to you, it’s the right time to seek guidance from an experienced fixed-income advisor.
When it comes to buying bonds, the guidance of an experienced advisor is invaluable. Our team at The DRL Group, with over three decades of bond trading experience, has successfully navigated clients through extraordinary market circumstances. Our seasoned professionals understand market dynamics, having guided clients through the extremes from the Dot-Com burst through the 2008 Financial Crisis, to the COVID-19 Pandemic. This level of experience is rare and an invaluable asset to investors. You can trust our expertise to guide you through the complexities of municipal bond investing.
To continue to receive timely information on bond markets, Sign up here for the free DRL Muni Market Insider.
