Property Tax Revenues Drive Stability for Local General Obligation Bonds

The SNW Investment Team maintains a stable outlook on the Local General Obligation Bond (Local GO) Sector and recommends a marketweight allocation to it. We expect Local GO credits to provide stability relative to other tax-backed sectors, as well as to more economically sensitive revenue bond sectors. We also expect that credit spreads in the sector will be less volatile than in other sectors. The outlook assumes that the level of issuance of Local GO bonds will remain in line with recent trends.

Property taxes are the primary source of revenue to repay Local GO bonds, and we continue to expect that they will provide stable revenue. Property valuations underlying tax revenues have had robust growth, and even in the event of an economic downturn, property tax provisions typically create a banking of gains that can offset decreased valuation. Given the lags between economic activity and property tax collections, we expect that any impacts from a downturn in real estate conditions would not be realized until the 2020 or 2021 fiscal years.

Despite recent financial market performance, pension liabilities remain a long-term credit issue due to changing demographics, growing expenditures and continually increasing contribution levels. The type of GO pledge can mitigate the impact of pensions or other factors. 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.

The SNW Investment team has seen tactical opportunities for value in the Local GO Sector, particularly with some mid-grade quality bonds in the A rating category. We will continue to look for opportunities to invest in Local GO credits that provide credit stability and value.

Source: SNWAM Research