McCalpin’s Unofficial Guide to Municipal Bonds
by William "Bill" McCalpin
Types of Bonds
The City of Richardson issues three kinds of bonds:
- Revenue bonds
- Certificate of Obligation (CO)
- General Obligation (GO)
The following definitions are derived from those used by the City of Dallas:
Types of bonds used by the City of Richardson
| REVENUE BONDS |
Bonds used for funding permanent capital improvements for an enterprise fund such as water and wastewater. The repayment of these bonds is made from the revenues of the enterprise fund. |
| CERTIFICATE OF OBLIGATION (CO) |
A written promise secured by the full faith and credit of the City. Used for funding permanent capital improvements. Debt Service is paid from ad valorem taxes (property taxes) or system revenues. |
| GENERAL OBLIGATION BOND (GO) |
Bonds used for funding permanent public capital improvements such as buildings, streets, and bridges. The repayment of these bonds is made from the levy of property tax. Voter approval is required to issue these bonds. |
As you can see, revenue bonds are bonds issued to cover capital improvements in one of the “systems” in a city, such as water, solid waste, and the like. The revenue bonds will be repaid out of the revenues generated that system’s operations. For example, a revenue bond to pay for some improvements in the water system would be repaid by revenue from the operations of the City’s water system. Because the revenue of one of a city’s systems or “funds” is not as secure collateral as the full property tax base of the city, revenue bonds are not generally rated as highly as COs and GOs. This means that the interest that the city must pay on the revenue bonds is generally higher than the interest paid on COs and GOs.
Note that while the City has sold revenue bonds in the past, it currently has none outstanding, preferring in many cases to issue COs instead.
As you can see from the definitions, unlike revenue bonds, both Certificates of Obligation and General Obligation bonds are backed by the City’s property tax base. The City’s property tax base is considered the most secure asset of the City; therefore, investors are willing to accept lower interest rates on COs and GOs than on revenue bonds.
The difference between COs and GOs is simply this: the voters must approve the issuance of GOs while the City Council has the authority to issue COs on its own (with the appropriate public notification). There is no magic formula that dictates when the City Council should issue a CO over a GO. Instead, the City Council makes that choice when, in its opinion, the amount of capital projects and proposed bonds becomes large enough that it feels that it would be appropriate to involve the voters by a formal election.
Therefore, for more routine capital expenses – especially between bond election cycles – the City authorizes the issue of COs. For example, in 2009, the City issued COs for
COs Issued by the City in 2009
| $2,700,000 |
General Fund Equipment |
4-Year |
| $720,000 |
Fire Equipment |
8-Year |
| $1,980,000 |
Fiber Optic Program |
14-Year |
| $5,000,000 |
Water and Sewer Rehabilitation |
20-Year |
| $1,400,000 |
Solid Waste Equipment |
8-Year |
Note that the City could have issued revenue bonds for at least the water system and solid waste expenses, but chose to issue COs because they could be sold with lower interest rates since they are backed by the City’s property tax base, not just the revenue of the water or solid waste operations in the City. However, the City normally repays the COs out of the system operations just like for revenue bonds, so it’s as if the City issued revenue bonds, but the taxpayers pay a lower interest rate (because of the superior credit rating that COs and GOs have).
Periodically, the City collects a large number of projects – often City-wide – together into a single offering and calls for an election for authorize GOs. The City does this only when the proposal is quite large, because calling an election costs money (the City pays the elections department of Dallas County to conduct the actual election, even for the Collin County portion of Richardson). Furthermore, the City during the normal course of operations issues debt instruments nearly every year, and it would be impractical to ask the taxpayers to vote in bond elections every year.
So, in short, GOs are used for large and comprehensive projects that may last multiple years, whereas the COs are used for more targeted and specific purposes; COs are sold nearly every year for one purpose or another.
Length of Bonds
The length of time over which bonds mature is generally a function of the lifetime of usefulness of the “asset” that the bond is funding. That is, if a bond will be used to purchase fire equipment that is expected to have a useful life of 8 years, then the bond will likely be set to mature in 8 years. On the other hand, improvements such as to sewer or water lines can be expected to last 20 or 30 years or more; in this case, the bonds will be set to mature anywhere from 1 to 20 years, in order to give investors the option to choose a given length of maturity or to suit the current market conditions.
In the table above, note that the fire equipment is expected to last 8 years, but the “general fund equipment” is expected to last on 4 years; hence the shorter maturity on the COs on the latter.
Editorial Note: McCalpin's Unofficial Guide expresses no opinion on the 2010 bond election or any bond propositions – it is purely informational for all residents. All of the information expressed in McCalpin's Unofficial Guides is purely the opinion of the author. The Richardson Echo publishes this as a service but does not endorse nor refute its contents.