General Obligation Bonds

Definition

The term general obligation bond is used to describe a debt security issued by state or local governments.  Unlike a revenue bond, which is secured by a specific income-generating entity, a general obligation bond is secured by the municipality's pledge to use all legally available means, specifically tax revenues, to repay this debt.

As is the case with other debt, if a municipal bond is issued for a term of five years or more, they represent a long term obligation and are shown in the long term liabilities section of the balance sheet.

Explanation

Issuing long-term bonds represents an important source of financing for many municipalities.  General obligation bonds are secured by the full faith and credit of the issuing municipality.  To fulfill this commitment, local governments will include a pledge to increase property taxes to repay this debt.  This means bondholders have a right to demand the borrowing agency impose such a tax to satisfy this obligation.

For this reason, credit rating agencies consider a general obligation bond's risk of non-payment to be very small, and typically reward these securities with investment grade ratings.

Normally, there are two types of general obligation bonds:

  • Limited-Tax:  a statutory limit is placed on the amount of property tax the local government is permitted to impose to repay this debt.
  • Unlimited-Tax:  there is no limit to the amount of property tax the local government is permitted to impose to repay this debt.  Local governments wishing to issue unlimited-tax obligations may be required to first seek approval via a public vote.

In practice, the issuing entity has three potential sources of revenue:  it can use a portion of property taxes already in-place, it can increase property taxes, or it can use an alternate source of revenue.

Related Terms

liabilities, long-term liabilities, interest expenseregistered and bearer bondsincome bonds, revenue bonds, accreting principal swap, adjustment bond