Property Tax Growth Provides Stable Foundation for Local General Obligation Bonds Offsetting Operational Pressures on State and Local Governments

The SNWAM Investment Team maintains a stable outlook on the Local General Obligation Bond (Local GO) Sector and recommends a marketweight allocation to the sector. The Local GO outlook was the focus of our sector analysis for our June Muni Credit Strategy Meeting. Our outlook is based on expectations for continued growth of property tax bases from which revenues are generated to pay debt service for Local GO bonds. Our analysis also assumes that the level of issuance of Local GO bonds will remain in line with recent trends, and we have incorporated the relatively fair pricing of the overall sector.

While Local GO bonds are typically backed by property taxes levied for debt service, credit quality can also be impacted by the operating performance of a municipality, including fiscal flexibility, budget trends, reserve levels and liabilities such as pensions and other retirement benefits. The operating performance of local governments, particularly public schools, may also be impacted by the financial performance, economics, and budget politics at the state level. Local GOs issued by school districts are often correlated to the GO debt or credit quality of their state due to state school funding formulas as well as the school bond credit enhancement programs provided by numerous states. 

The type of GO pledge can also impact credit quality. Local GO bonds backed by unlimited tax pledges provide stronger bondholder protections than limited tax GOs, and the risk profile of the unlimited tax GO is significantly lower than local appropriation debt despite recent rating agency upgrades to such debt.

The SNW Investment team has seen tactical opportunities for value in the sector. We will continue to look for opportunities to invest in Local GO credits that provide credit stability and increased value.