Municipal securities: general obligation and revenue bonds, other types, and their tax treatment

Follow the repayment pledge

Municipal securities are obligations of governmental entities such as cities, counties, and public authorities. Separate repayment backing from tax treatment.

A general obligation (GO) bond pledges the issuer's full faith and credit and taxing power, subject to applicable limits. A public school financed from general resources is a typical example. Analyze the tax base, collection capacity, debt burden, and economy. Limited tax and unlimited tax pledges differ in the issuer's authority to raise taxes.

A revenue bond pledges specified revenues rather than general taxing power. Water charges or airport receipts can support repayment. Analyze demand, operating costs, rates, debt service coverage, and covenants. A revenue pledge need not be a mortgage on the facility.

Other structures and maturities

• Double barreled bonds: both a revenue pledge and general obligation backing.
• Special assessment bonds: charges against properties benefiting from an improvement.
• Moral obligation bonds: a nonbinding commitment to consider replenishing a reserve, distinct from an enforceable GO pledge.
• Industrial development and other conduit bonds: commonly depend on a private borrower's payments and credit.
• Tax anticipation notes, revenue anticipation notes, and bond anticipation notes: short term financing repaid from anticipated taxes, revenues, or a later bond issue, respectively.
• Serial bonds: installments mature on different dates. Term bonds: a common maturity for the relevant issue or portion.

Federal tax treatment

Municipal interest is generally exempt from federal income tax. Exceptions include nonqualified private activity bonds and arbitrage bonds. Some qualified private activity interest can affect alternative minimum tax. A sale gain is separate from interest income. Tax advantages do not eliminate credit, interest rate, liquidity, or call risk.

Tax-equivalent yield = municipal yield divided by (1 minus marginal federal tax rate). At a 3% tax-exempt yield and a 25% tax rate, divide 3% by (1 minus 25%) to get 4%. This compares income after federal tax; it does not equate credit quality or other bond terms.