Understanding General Obligation Municipal Bonds

Given all the municipal bonds to choose from, how do you decide which ones should make up the core of your portfolio? With $3.9 trillion of muni debt outstanding1 spread among tens of thousands of issuers, the choice may seem daunting, but we’ll help you break it down.

Municipal bonds are sold by local and state governments to help fund public projects or municipal government operations, like building new schools or repairing city sewer systems. Their interest payments are usually exempt from federal income taxes, and may be exempt from state income taxes if the bond issuer is located in the investor’s home state. For these reasons munis are often attractive to income-oriented investors in higher tax brackets looking to reduce income tax bills.

Munis can generally be classified into two camps—general obligation bonds and revenue bonds. General obligation, or GO, bonds are often backed by the general revenue of the issuing municipality, while revenue bonds are supported by a specific revenue source, such as revenue from a toll road.

In this article, we’ll focus on GO bonds. They account for 27% of the investment-grade muni market and are usually backed by the taxing authority of the bond issuer. Most states and local governments issue GO bonds to help fund operations or specific projects. The dollar value of GOs issued by states compared to local governments is roughly equal, even though there are fewer states than local governments. In other words, the amount of debt issued per state is much larger than the amount of debt issued per local government.

General obligation bonds make up about a quarter of the muni market