Professional Documents
Culture Documents
Long-Term Debt Bonds are the primary source of long-term debt for local governments
Bonds
A bond is a debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing. The Federal government, states, cities, corporations, and many other types of institutions sell bonds. Generally, a bond is a promise to repay the principal along with interest (coupons) on a specified date (maturity).
Types of Bonds
There are commonly two types of bonds:
General
Revenue
Unlimited-tax GO bonds are secured by the full faith, credit, and taxing powers of the issuing government
Legally obligate the local government to levy taxes on all assessable property within its jurisdiction to a level necessary to meet the bond payment obligation
GO bonds are an appropriate financing vehicle for capital projects that benefit the community as a whole.
May be limited by constitutional and statutory restrictions. Normally require voter approval
Revenue Bonds
Revenue bonds are secured by the revenues from the project being financed
Their credit strength depends upon the financial strength of the capital project
Revenue Bonds
Common types of revenue bonds include: Airport revenue bonds Hospital and nursing home revenue bonds Public power revenue bond Water and sewer revenue bonds Sports complex and convention center revenue bonds
Bond Rating is an independent assessment It is associated with purchase and holding a particular bond It assesses relative credit risk Ratings indicate likelihood that the obligation will be repaid
Ratings are given by independent rating agencies Ratings are independent source of information and analysis for capital markets Primary agencies rating municipal debt Fitch IBCA Inc., Moodys Investors Service and Standard & Poors Rating Services
Debt management using key financial ratios such as debt per capita
Administrative issues relating to direct authority of governments responsibility Financial performance analyzing revenues and expenditure trends
Economic outlook based on tax base, income, population, employment and others
Service Base also included for Revenue Bonds
compare relative risks of different debt issues Ratings scale is a consistent framework for comparisons Each agency has it own rating scale
A high bond rating (e.g. AAA) indicates low credit risk to investor
Borrowing will be less costly for an issuer with higher rating than with lower rating
For each drop in ratings, bond issuers pay additional basis points (a basis point is 1/100 of a percentage point) When in millions, a few basis points can translate into thousands of dollars
Bond Pricing
Bonds can be priced at a premium, discount, or at par. If the bonds price is higher than its par value, it will sell at a premium because its interest rate is higher than the current prevailing rates. If the bonds price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing rates.
Example
The quoted price is usually based on the bond maturity at a price of par, or 100.00. In the case of a bond 6% of June 1, 2008, if the price is $105.13, this means the bond is at a 5.13% premium to its maturity price (par or 100.00). An investor who pays $105.13 for the bond will receive only $100.00 back on maturity. Conversely, bond selling at a price that is less than its par value is selling at a discount.
Pays 2% annual interest Issues bonds at premium at $15,000,000 Total Interest cost over 30 years 15,000,000 x 0.02 x 30 = $9,000,000
Pays 7% annual interest Issues bonds at discount at $7,000,000 Total Interest cost over 30 years 7,000,000 x 0.07 x 30 = $14,700,000
Investors use bond ratings as they are easy to access and understand Investors consider ratings as indication of governments overall fiscal health
Even if the local govt. sells the bond, investors will pay less to compensate for uncertainty Bond ratings necessary only if issue is larger than $1million
Until the Bond expires Changes if there is an upgrade or downgrade in the ratings over time Rating agency withdraws ratings due to insufficient information
Rating agencies use debt indicators They study both debt outstanding and debt service as indicators of debt burden Current year and long term financial projections News and other publicly available information
Example: County A has General Obligation Debt of $40,000,000 on a Fair Market Value of 1,000,000,000 of taxable property.
Debt as a % of FMV = 40,000,000 /1,000,000,000 = 0.040 or 4% Uses: Important measure of local governments wealth available to support present and future tax taxing capacity to meet debt obligations
Debt as a % of per capita income = $4,000,000/$35,000 = .875% Uses: Realistic estimate based on the assumption that all taxes and therefore the total principal debt are paid by the citizens
Example: County A has Property Tax Revenue of $10,000,000 and debt service amount of $4,000,000.
Debt as a % of Property Tax Revenue: = 4,000,000/10,000,000 = 0.40 or 40% Uses: Particularly useful for evaluating cities that rely heavily on property taxes
Debt as a % of per capita income = $40,000,000/$35,000/20,000 = 5.7% Uses: Annual per capita burden on the citizens based on the assumption that all taxes and therefore the principal and interest payments are paid by the citizens
Uses: Reflects that total resources appropriated by local government can exceed revenues due to transfer from another fund, balance due to other borrowings. Also identifies relative spending priorities such as how much is spent on debt service vs current services like public safety
General Fund Balance Cash Flows Net Operating Position Revenue Structure Revenue & Spending Growth Rates Revenue Forecasts Property Tax Collection Rates Local Tax Burden Tax Cap & Limitations
Expenditures by function Labor Settlements & Litigations Unfunded Pension Obligations Capital Improvement Plan Trends Debt Ratios Debt Capacity Number of Employees
Population Per Capita Income Unemployment Education Levels Median Age Vacancy Rates for Downtown Buildings
New Housing Rates Building Permits Construction Value Major Construction Projects Largest Employers Fair Market Value of Property
2.
3.
4.
Establish rainy day and budget stabilization reserves Review economic and revenue trends to identify potential budget problems Prioritize spending and establish contingency plans for budget shortfalls Develop a formal capital improvement program and a debt affordability model
7.
8.
Incorporate pay-as-go financing in capital plans and operating budgets Anticipate the impact of capital and operating budgets in a multiyear financial forecast. Establish benchmarks and priorities Establish and maintain effective management systems
10.
Consider the affordability of actions and plans before they become a part of the budget Have a well-defined and coordinated economic development strategy
References
1.
Capital Budgeting and Finance: A Guide for Local Governments A. John Vogt, International City/County Management Association, 2004
2.
Management Policies in Local Government Finance Fifth Edition, International City/County Management Association, 2004
http://www.investorwords.com Investopediahttp://www.investopedia.com/univer sity/advancedbond/advancedbond2.asp
2.
2.
http://lgc.uwex.edu/