Five year municipal credit ratings for long term investors
So, Just What Are General Obligation Bonds?
There are actually three kinds of government GO’s. They are: 1) Unsecured GO’s backed by an unconditional promise to pay from all available revenue and taxes. This kind of GO is the fodder for chapter 9 bankruptcies. Unsecured corporate bonds fall into this category in chapter 11.
Outside of bankruptcy, the obligation is absolute and unconditional i.e., no way out in the same manner as the unsecured general obligations of individuals, and corporations.
2) GO’s secured by a lien on and security interest in taxable property that is unlimited as to rate and constitutes the sole source of payment for the debt.
Secured GO’s, 2 above, can be immune to or excluded from a chapter 9 filing if conditions specified in the Chapter 9 Code are met.
Under the code, “special revenue” secured debts are exempt from court ordered write downs. However, that does not mean exempt or immune from monetary default.
Special revenue secured bonds must 1) a have a lien on and security interest in a single source revenue dedicated exclusively to payment of P&I, 2) be issued for an essential public purpose, and 3) authorized by the state to file a security interest and lien on what the court has defined as “special revenue”.
Only about one half of the states have elected to permit subdivisions to file for bankruptcy protection. Out of the ones that do, not all also allow sub divisions the authority to file security interests. Answers are found by case by case examination.
The “special revenue” provision exists only in chapter 9 for municipalities and state agencies/corporations. It is there to provide an equivalent to secured corporate debt because in nearly every state, municipalities are prohibited from pledging or mortgaging their infrastructure to secure payment of debts.
Special revenue secured debt can also be found among municipal and state sponsored essential service enterprise revenue bonds. Issued for water, sewer, electric, gas, and garbage disposal purposes, they are payable solely from charges for service. Certain local tax revenue bonds may qualify as well.
3) GO Bonds issued by states. There is no federal law or court that has the authority or jurisdiction to write down any direct debt incurred pursuant to the states constitutions. The buck stops there.
The last state to default on direct debt was Mississippi in 1933. They eventually paid in full because the State realized it could not survive let alone prosper without access to credit. Today, markets move at lighting speed compared to the 1930’s.
Lastly I would be remiss if I did not comment the grossly misleading impression that GO bonds have suffered write downs much greater than pensions in local government bankruptcies going back to orange County California.
Actually, in each case, those municipalities issued large amounts of pension funding bonds, payable from non-mandatory annual appropriation.
The write down on these non-debt debts is typically 100%, 87% or 13 cents on the dollar recovery in the case of Detroit because the issue was also secured by a gaming tax covering about 13% of P&I.
By including these write downs along with small amounts of GO losses, the press has made GO bond losses versus pensions appear much greater than is actually the case.
Carl Dincesen 2016
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