Municipal bonds are generally used by governmental issuers for long-term financing of capital projects. Maturity dates are typically between one and 30 years from issuance. Interest may be paid either at a stated fixed rate, or at a variable interest rate that is determined from time to time based on a stated process or formula.
Payment of principal and interest on a municipal security may be backed by various types of pledges and forms of security. Below is a general description of some of the more common sources of security for payment of principal and interest. For detailed information about a specific bond, refer to its official statement which will typically be available on the MSRB's EMMA website.
General Obligation Bonds
The term “general obligation” is used to describe a debt security in which the full faith, credit and taxing power of the issuer is pledged to pay principal and interest. General obligation bonds issued by local governments typically include a pledge to use the issuer’s ad valorem taxing power to pay principal and interest. Ad valorem taxes necessary to pay debt service on general obligation bonds are often not subject to state constitutional property tax millage limits (an unlimited tax general obligation bond). The term limited tax is used when such limits exist.
General obligation bonds constitute debts of the issuer and often require approval by voters prior to issuance. In the event of default in required payments of interest or principal, the holders of general obligation bonds typically have certain rights to compel a tax levy or a legislative appropriation.
“Revenue bond” is the term used generally to describe a bond that is payable from a specific source of revenue and to which the full faith and credit of an issuer with taxing power is not pledged. The issuer of a revenue bond is not obligated to pay principal and interest on its bonds using any source other than the source(s) specifically pledged to the bond. Revenue bonds are payable from identified sources of revenue and do not permit the bondholders to compel taxation or legislative appropriation of funds not pledged for payment of debt service. Pledged revenues may be derived from operation of the financed project, grants or excise or other specified non-ad-valorem taxes. Generally, no voter approval is required prior to issuance of such obligations. If the specified source(s) of revenue become inadequate, a default in payment of principal or interest may occur. Various types of pledges of revenue may be used to secure interest and principal payments on revenue bonds. The nature of these pledges may differ widely based on the type of issuer, type of revenue stream, and other factors.
Some revenue bonds are issued by governmental agencies to fund facilities for essential public services. A bond issued by a municipal water and sewer authority, for example, typically would involve revenues obtained through local water and sewer assessments. The pledge of revenue would identify specific assessments that can be used to pay principal and interest on the bonds, the authority’s responsibility and ability (if any) to raise water and sewer assessments, and any superior claim on the assessments, for example.
Another type of revenue bond may be issued by a governmental issuer acting as conduit for the benefit of a private sector entity or a 501(c)(3) organization. In these cases, the governmental issuer is seeking to advance specific public purposes within its mission, with such conduit bonds commonly issued for not-for-profit hospitals, single and multi-family housing, airports, industrial or economic development, student loan programs, and redevelopment programs. Principal and interest on such bonds normally are paid exclusively from revenues pledged by the entity receiving financing (the obligor). Unless otherwise specified under the terms of the bonds, the issuer is not required to make payments of principal or interest if the obligor defaults.
The term “double-barreled bond” is used to describe bonds secured by a defined revenue source as well as the full faith and credit of an issuer that has taxing power. It has both general obligation and revenue pledges.
Moral Obligation Bonds
The term “moral obligation bond” refers to a bond, usually issued by a state or agency, that is secured by a non-binding covenant that any amount necessary to make up any deficiency in pledged revenues available for debt service will be included in the budget recommendation made to the state legislature or other legislative body, which may appropriate moneys to make up the shortfall. The legislature or other legislative body, however, is not legally obligated to make such an appropriation. Unlike a general obligation pledge, the moral obligation bond does not require voter approval and does not have the state’s official pledge of its full faith and credit.