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The State of California is back to issuing bonds.  After a slow start to the year, mired in budget woes and political mudslinging, California made the choice to delay some new issue general obligation bond deals.  Now that California has an approved budget for fiscal 2012, the deal flow is ready to hit the market, and it is essential for investors to understand how general obligation bonds work.  Investors should understand their investments, and the upcoming California General Obligation bond deal, with a sale date of September 20, 2011, could present an enticing opportunity for the right investors.

General obligation bonds may be issued at both the local and state levels.  At the local level, general obligation bonds are voter approved, and backed by a pledge to levy ad valorem (or according to value) taxes in an unlimited amount on property in the municipality’s area in order to satisfy principal and interest payments when due.  In other words, the municipality is required to use their taxing power to levy property taxes in an unlimited amount to satisfy debt service requirements.  At the state level, general obligation bonds are secured by the full faith and credit of the State, and the debt service is paid out of the general fund.  The Constitution of the State of California details that only school funding has a higher priority in general fund spending than the payment of general obligation bond debt service.  Fundamentally, the State would be required to miss payments on several other essential services before they would miss a payment on their general obligation debt.

The State of California has struggled in recent years to create a balanced budget, but positive aspects have emerged from the budget turmoil.  In past years, the budget was balanced using one time fixes that may merit using the phrase that politicians, “kicked the can down the road,” in regards to its budget issues.  For fiscal 2012, however, the budget was balanced using some optimistic revenue assumptions, while creating a buffer in the event the optimistic assumptions fail to materialize.  The State has until December 15th to determine the success of their optimistic revenue assumptions, and if they fail to materialize, the State has already approved a series of automatic spending cuts to help balance the budget.  California does have a high debt load relative to many other states, but debt service represents a manageable 7.6% of general fund expenditures.

Due to the taxing ability of municipalities, and the priority of payments, general obligation bonds are often viewed as being among the safer types of municipal bonds.  To contrast, municipal bonds such as revenue bonds are often dependent on the revenue of a specific project, and certificates of participation often have equal priority to other general fund obligations.  Most California residents continue to pay their property taxes, and continue to pay their state income taxes, which help support the varying types of general obligation bonds.  While budget issues could persist in the proceeding years, general obligation bonds have a clear path to debt service payments, which could help their owners’ sleep well at night.

Billy Schmohl
Investment Information Coordinator

This report is prepared for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument or service.  Market prices and other data may be obtained from outside sources and is not warranted as to completeness or accuracy. Any comments, statements and/or recommendations made herein are subject to change without notice, and may not necessarily reflect those of Alamo Capital.  Alamo Capital has no affiliation with any political party. Investing involves risk. Consult with a Financial Professional for additional information to determine the suitability of this or any other financial product or issue as it relates to your particular situation.