Financial Management Series Number 5 DEBT MANAGEMENT Financial Management Series Number 5 DEBT MANAGEMENT Alan Probst Local Government Specialist Local

Financial Management Series Financial Management Series Number 5Number 5

DEBT MANAGEMENTDEBT MANAGEMENT

Alan ProbstAlan ProbstLocal Government SpecialistLocal Government SpecialistLocal Government CenterLocal Government CenterUniversity of Wisconsin - ExtensionUniversity of Wisconsin - Extension

Financial Management Series Financial Management Series Number 5Number 5

DEBT MANAGEMENTDEBT MANAGEMENT

Alan ProbstAlan ProbstLocal Government SpecialistLocal Government SpecialistLocal Government CenterLocal Government CenterUniversity of Wisconsin - ExtensionUniversity of Wisconsin - Extension

Capital Financing StrategyCapital Financing StrategyCapital Financing StrategyCapital Financing Strategy

A Capital Financing Strategy is A Capital Financing Strategy is essential for any local government to essential for any local government to effectively plan for major projects and effectively plan for major projects and expendituresexpenditures

Debt ManagementDebt Management is one of the key is one of the key components of a financial strategy. components of a financial strategy.

Guiding PrinciplesGuiding PrinciplesGuiding PrinciplesGuiding Principles

Borrowing for operating expenditures Borrowing for operating expenditures is generally unsoundis generally unsound

Borrowing for capital projects is Borrowing for capital projects is considered essential financial decision-considered essential financial decision-makingmaking

Borrowing for capital projects requires Borrowing for capital projects requires effective debt managementeffective debt management

Guiding PrinciplesGuiding PrinciplesGuiding PrinciplesGuiding Principles Effective debt management can Effective debt management can

minimize interest costs and even minimize interest costs and even stabilize local government financial stabilize local government financial positionspositions

Periodic review of debt and re-Periodic review of debt and re-financing when conditions are financing when conditions are favorable are essential to effective debt favorable are essential to effective debt management and capital planning management and capital planning

Guiding PrinciplesGuiding PrinciplesGuiding PrinciplesGuiding Principles

Manage debt to borrow for the right Manage debt to borrow for the right projects at pre-determined projects at pre-determined borrowing points that maximize the borrowing points that maximize the government’s borrowing efficiencygovernment’s borrowing efficiency

State LimitationState LimitationState LimitationState Limitation

Wisconsin Constitution limits Wisconsin Constitution limits county, municipal, and town county, municipal, and town borrowing and other debt to borrowing and other debt to 5%5% of of equalized taxable propertyequalized taxable property

Local Debt CapacityLocal Debt CapacityLocal Debt CapacityLocal Debt Capacity

Some commonly used ratios can Some commonly used ratios can provide guidance on debt affordabilityprovide guidance on debt affordability

Ratios allow you to compare your Ratios allow you to compare your situation to statewide averages or situation to statewide averages or similar-sized communitiessimilar-sized communities

Common RatiosCommon RatiosCommon RatiosCommon Ratios

For a local government to decide how much For a local government to decide how much debt it can afford to issue, it must look at debt it can afford to issue, it must look at bond and debt ratios. Common ratios are:bond and debt ratios. Common ratios are:

Net debt per capitaNet debt per capita Net debt as a % of taxable or market Net debt as a % of taxable or market

valuationvaluation Annual debt service on net debt as a % of Annual debt service on net debt as a % of

general fund revenues or spendinggeneral fund revenues or spending

Local Debt CapacityLocal Debt CapacityLocal Debt CapacityLocal Debt Capacity

All ratios refer to “Net debt”All ratios refer to “Net debt”

Net Debt is debt that is paid for from Net Debt is debt that is paid for from general revenues or taxesgeneral revenues or taxes

Includes General Obligation bondsIncludes General Obligation bonds

Debt ServiceDebt ServiceDebt ServiceDebt Service

The Wisconsin Constitution also The Wisconsin Constitution also specifics specifics HOW HOW and and WHENWHEN local local government debt must be government debt must be repaidrepaid

Financial StatusFinancial StatusFinancial StatusFinancial Status

Before a governmental body decides to borrow Before a governmental body decides to borrow or sell debt, it needs to determine its or sell debt, it needs to determine its financial status, i.e. whether it can afford to financial status, i.e. whether it can afford to incur debtincur debt

Is the General Fund balance adequate?Is the General Fund balance adequate? How close to the Constitutional debt limits How close to the Constitutional debt limits

are you before incurring additional debt?are you before incurring additional debt? What is your ability to borrow, such as What is your ability to borrow, such as

bond rating?bond rating?

General Fund BalanceGeneral Fund BalanceGeneral Fund BalanceGeneral Fund Balance

General Fund balance must be adequate to General Fund balance must be adequate to ensure continued positive cash flowensure continued positive cash flow

A common guideline is to maintain six (6) A common guideline is to maintain six (6) months operating expenditures as a reservemonths operating expenditures as a reserve

If you have an insufficient General Fund If you have an insufficient General Fund balance, you cannot be assured of your balance, you cannot be assured of your ability to continue operations and service ability to continue operations and service new debtnew debt

Debt LimitDebt LimitDebt LimitDebt Limit

By law, you cannot borrow additional By law, you cannot borrow additional funds if your borrowing will place your funds if your borrowing will place your debt beyond the Constitutional debt debt beyond the Constitutional debt limitlimit

If you borrow to your debt limit, you If you borrow to your debt limit, you have no recourse for additional funds have no recourse for additional funds in the case of emergenciesin the case of emergencies

Bond RatingBond RatingBond RatingBond Rating

Bond ratings are an evaluation of the Bond ratings are an evaluation of the insurer's credit quality rated by:insurer's credit quality rated by:

Moody’s Investors ServiceMoody’s Investors Service

Standard & Poor’s (S&P)Standard & Poor’s (S&P)

Fitch RatingsFitch Ratings


Bond rating is determined by your financial Bond rating is determined by your financial stability and perceived ability to repay debtstability and perceived ability to repay debt

A rating of “AAA” is most desirableA rating of “AAA” is most desirable Any rating of less than “A” will probably Any rating of less than “A” will probably

incur an unacceptable interest rate.incur an unacceptable interest rate. A rating of “C” or “D” effectively places you A rating of “C” or “D” effectively places you

in the “junk bond” rangein the “junk bond” range


Your bond rating is influenced by such Your bond rating is influenced by such factors as:factors as:

General Fund ReserveGeneral Fund Reserve Audit findingsAudit findings Revenue projectionsRevenue projections The stability of your local governmentThe stability of your local government Past payment performancePast payment performance State and local policiesState and local policies

Types of FinancingTypes of FinancingTypes of FinancingTypes of Financing

““Pay-as-you-gPay-as-you-go” Financingo” Financing

““Pay-as-you-use” FinancingPay-as-you-use” Financing

Debt FinancingDebt Financing

““Pay As You Go” FinancingPay As You Go” Financing““Pay As You Go” FinancingPay As You Go” Financing

Pays for capital projects and acquisitions Pays for capital projects and acquisitions from sources other than debt such as from sources other than debt such as current taxes and revenue; funds from current taxes and revenue; funds from Capital Reserves; special assessments Capital Reserves; special assessments or impact fees; and grant revenue from or impact fees; and grant revenue from federal, state, or foundation sourcesfederal, state, or foundation sources

““Pay As You Go” FinancingPay As You Go” Financing““Pay As You Go” FinancingPay As You Go” Financing

Saves interest chargesSaves interest charges Capital projects must be evenly spaced Capital projects must be evenly spaced

over timeover time Needed projects have to be delayed Needed projects have to be delayed

until necessary funds can be until necessary funds can be accumulatedaccumulated

Not equitable if the population is Not equitable if the population is relatively mobilerelatively mobile

““Pay as You Use” FinancingPay as You Use” Financing““Pay as You Use” FinancingPay as You Use” Financing

Every long-term improvement or Every long-term improvement or expenditure is financed by serial debt expenditure is financed by serial debt issues with maturities arranged so that issues with maturities arranged so that retirement of debt coincides with the retirement of debt coincides with the depreciation of the projectdepreciation of the project

When a projects' useful life finally ends, When a projects' useful life finally ends, the last dollar of debt is paid offthe last dollar of debt is paid off

““Pay as You Use” FinancingPay as You Use” Financing““Pay as You Use” FinancingPay as You Use” Financing

Avoids many of the problems of “pay Avoids many of the problems of “pay as you go” financingas you go” financing

Everyone pays for the capital Everyone pays for the capital improvements they useimprovements they use

Ideally, all long-lived projects should be Ideally, all long-lived projects should be financed by debt that is retired over the financed by debt that is retired over the course of the project’s lifecourse of the project’s life

Debt FinancingDebt FinancingDebt FinancingDebt Financing

Money obtained by incurring debt and Money obtained by incurring debt and used to build or acquire capital assets used to build or acquire capital assets or other purposesor other purposes

Debt financing for local governments Debt financing for local governments

comes mainly from the issuance of comes mainly from the issuance of long-term bonds or other debtlong-term bonds or other debt


Commonly used for capital projects Commonly used for capital projects

Issuing debt to finance cash flow needs Issuing debt to finance cash flow needs or deficits in operating budgets is or deficits in operating budgets is sometimes done but should be sometimes done but should be restricted to extraordinary situationsrestricted to extraordinary situations


When using debt financing, a When using debt financing, a Financing Financing PlanPlan should be set up to show a should be set up to show a project’s anticipated effect on the local project’s anticipated effect on the local mil rate, the community’s financial mil rate, the community’s financial position, and credit rating.position, and credit rating.

ExpendituresExpendituresExpendituresExpenditures

Current expendituresCurrent expenditures: for goods and : for goods and services used within 1 year and services used within 1 year and reflected in the operating budgetreflected in the operating budget

Capital expendituresCapital expenditures: represent fixed : represent fixed assets that will provide services for a assets that will provide services for a number of yearsnumber of years

Virtually all long-term debt financing is Virtually all long-term debt financing is used to fund capital improvements, i.e. used to fund capital improvements, i.e. Capital FinancingCapital Financing

Capital Improvement Program Capital Improvement Program (CIP)(CIP)


Used to manage capital financing needsUsed to manage capital financing needs

Identifies capital projects to be funded Identifies capital projects to be funded over the next five or six yearsover the next five or six years

First year of CIP serves as First year of CIP serves as Capital BudgetCapital Budget



Serves as a financial planning tool:Serves as a financial planning tool:

1.1. Establishes priorities that balance Establishes priorities that balance capital needs with available resourcescapital needs with available resources

2.2. Pairs projects with their intended Pairs projects with their intended funding sourcesfunding sources


3.3. Ensures orderly improvement or Ensures orderly improvement or replacement of fixed assetsreplacement of fixed assets

4.4. Provides an estimate of the size Provides an estimate of the size and timing of future bond salesand timing of future bond sales

Debt PolicyDebt PolicyDebt PolicyDebt Policy

A written debt policy establishes guidelines for A written debt policy establishes guidelines for the use of debtthe use of debt

Specifies:Specifies:

1.1. Maximum amount of debt that can be Maximum amount of debt that can be issuedissued

2.2. Purposes for which debt can be issuedPurposes for which debt can be issued

3.3. Types of debt that can be issuedTypes of debt that can be issued

4.4. Debt maturity structureDebt maturity structure

Types of DebtTypes of DebtTypes of DebtTypes of Debt

Long-term debt:Long-term debt: General Obligation (GO) BondsGeneral Obligation (GO) Bonds Revenue BondsRevenue Bonds

Short-Term NotesShort-Term Notes

General Obligation (GO) BondsGeneral Obligation (GO) BondsGeneral Obligation (GO) BondsGeneral Obligation (GO) Bonds

Secured by the full faith, credit, and Secured by the full faith, credit, and taxing powers of the issuing taxing powers of the issuing governmentgovernment

Legally obligate the local government Legally obligate the local government to assess taxes as necessary to meet to assess taxes as necessary to meet debt service paymentsdebt service payments

For capital projects that benefit the For capital projects that benefit the community as a wholecommunity as a whole

General Obligation (GO) BondsGeneral Obligation (GO) Bonds

Limited only by statutory Limited only by statutory limitationslimitations

Normally require voter approvalNormally require voter approval

ExampleExampleExampleExample

A municipality issues a $12,000 General A municipality issues a $12,000 General Obligation Bond to build a state-of-the-Obligation Bond to build a state-of-the-art community recreation center, art community recreation center, projected to last for 25 years plus, projected to last for 25 years plus, which was approved in an advisory which was approved in an advisory referendum referendum

The bond is issued at 4.15% interest over The bond is issued at 4.15% interest over a 20 year perioda 20 year period

Revenue BondsRevenue BondsRevenue BondsRevenue Bonds

Secured by the revenues of the project Secured by the revenues of the project being financedbeing financed

Their credit depends upon the financial Their credit depends upon the financial strength of the financed projectstrength of the financed project

Typically do not require voter approvalTypically do not require voter approval

Revenue BondRevenue Bond examples examples

Revenue BondRevenue Bond examples examples

1.1. Airport revenue bondsAirport revenue bonds

2.2. Hospital or nursing home revenue bondsHospital or nursing home revenue bonds

3.3. Industrial development revenue bondsIndustrial development revenue bonds

4.4. Public power revenue bondsPublic power revenue bonds

5.5. Resource recovery revenue bonds Resource recovery revenue bonds

6.6. Sports complex and convention center Sports complex and convention center revenue bondsrevenue bonds

7.7. Water and sewer revenue bondsWater and sewer revenue bonds

Other long-term financing Other long-term financing vehiclesvehicles

Other long-term financing Other long-term financing vehiclesvehicles

Special assessment bondsSpecial assessment bonds Finance capital improvements that benefit a specific Finance capital improvements that benefit a specific

areaarea User fee levied on propertyUser fee levied on property

Tax increment financing bondsTax increment financing bonds Promotes economic development in a specific areaPromotes economic development in a specific area Paid from the increase in property tax revenues Paid from the increase in property tax revenues

generated as a result of the economic growthgenerated as a result of the economic growth

Short-term notesShort-term notesShort-term notesShort-term notes

Governments may issue short-term notes Governments may issue short-term notes which have maturities of less than which have maturities of less than thirteen (13) monthsthirteen (13) months

Bond anticipation notesBond anticipation notes Tax anticipation notesTax anticipation notes Revenue anticipation notesRevenue anticipation notes Grant anticipation notesGrant anticipation notes Tax and revenue anticipation notesTax and revenue anticipation notes

CAUTION!CAUTION!CAUTION!CAUTION!

If considering whether to borrow between If considering whether to borrow between funds, remember:funds, remember:

In your local government accounting In your local government accounting processes, you can processes, you can NEVERNEVER cover deficits in cover deficits in unrestricted fund balances with restricted unrestricted fund balances with restricted fundsfunds

This can be a “go to jail” issueThis can be a “go to jail” issue You can “borrow” by resolution but must You can “borrow” by resolution but must

have a plan for repayment and stick to ithave a plan for repayment and stick to it

Debt Maturity StructureDebt Maturity StructureDebt Maturity StructureDebt Maturity Structure

Determined by:Determined by:

Type of project being financedType of project being financed

Financial position of the issuerFinancial position of the issuer

Statutory constraintsStatutory constraints

MaturityMaturity Guiding PrincipleGuiding Principle MaturityMaturity Guiding PrincipleGuiding Principle

A bond issue should not exceed A bond issue should not exceed the useful life of the project the useful life of the project

being financedbeing financed

Bonds Bonds Bonds Bonds

A bond is a single security, A bond is a single security, typically with a principal amount of typically with a principal amount of $5,000$5,000

A $1 million bond issue consists of A $1 million bond issue consists of two hundred bonds, each with a two hundred bonds, each with a principle of $5,000principle of $5,000

BondsBondsBondsBonds

In a serial bond issue, portions of In a serial bond issue, portions of the total issue mature at different the total issue mature at different timestimes

Most sold in serial form with Most sold in serial form with maturities between one and fifteen maturities between one and fifteen years or longeryears or longer


Each year’s debt service must be Each year’s debt service must be included in the annual budgetincluded in the annual budget

Commonly under a debt service Commonly under a debt service fundfund


Debt service will include and should Debt service will include and should identify principle, interest, and fees on identify principle, interest, and fees on separate budget lines separate budget lines

Do not forget to budget for the annual Do not forget to budget for the annual fee on bondsfee on bonds

Basic Debt Management Basic Debt Management QuestionsQuestions

Basic Debt Management Basic Debt Management QuestionsQuestions

Does the project need to be done now or can Does the project need to be done now or can it wait for a more advantageous time?it wait for a more advantageous time?

Is our financial condition such that it can Is our financial condition such that it can support additional debt service?support additional debt service?

What are the current trends with interest What are the current trends with interest rates?rates?

What is our current bond rating?What is our current bond rating? What kind of maturity structure is most What kind of maturity structure is most

desirable at this time?desirable at this time?

SourcesSourcesSourcesSources

““Management Policies in Local Management Policies in Local Government Finance,” ICMA University, Government Finance,” ICMA University, 55thth Edition, 2004 Edition, 2004

““Capital Budgeting and Finance: A Guide Capital Budgeting and Finance: A Guide for Local Governments,” A. John Vogt, for Local Governments,” A. John Vogt, International City/County Management International City/County Management Association, 2004Association, 2004

Documents

Financial Management Series Number 5 DEBT MANAGEMENT Financial Management Series Number 5 DEBT MANAGEMENT Alan Probst Local Government Specialist Local