Question

What factors should a jurisdiction consider in setting debt policies?

Answer 1

Following are the factors should a jurisdiction consider in setting debt policies.

1. Debt Limits.

The Policy should consider setting specific limits or acceptable ranges for each type of debt. Limits generally are set for legal, public policy, and financial reasons.

a. Legal restrictions may be determined by:

• State constitution or law,
• Local charter, by-laws, resolution or ordinance, or covenant, and
• Bond referenda approved by voters.

b. Public Policies will address the internal standards and considerations within a government and can include:

• Purposes for which debt proceeds may be used or prohibited,
• Types of debt that may be issued or prohibited,
• Relationship to and integration with the Capital Improvement Program, and
• Policy goals related to economic development, including use of tax increment financing and public-private partnerships.

c. Financial restrictions or planning considerations generally reflect public policy or other financial resources constraints, such as reduced use of a particular type of debt due to changing financial conditions. Appropriate debt limits can have a positive impact on bond ratings, particularly if the government demonstrates adherence to such policies over time. Financial limits often are expressed as ratios customarily used by credit analysts. Different financial limits are used for different types of debt. Examples include:

• Direct Debt, including general obligation bonds, are subject to legal requirements and may be able to be measured or limited by the following ratios:
  • Debt per capital,
  • Debt to personal income,
  • Debt to taxable property value, and
  • Debt service payments as a percentage of general fund revenues or expenditures.

• Revenue Debt levels often are limited by debt service coverage ratios (e.g., annual net pledged revenues to annual debt service), additional bond provisions contained in bond covenants, and potential credit rating impacts.
• Conduit Debt limitations may reflect the right of the issuing government to approve the borrower’s creditworthiness, including a minimum credit rating, and the purpose of the borrowing issue. Such limitations reflect sound public policy, particularly if there is a contingent impact on the general revenues of the government or marketability of the government’s own direct debt.
• Short-Term Debt Issuance should describe the specific purposes and circumstances under which it can be used, as well as limitations in term or size of borrowing.
• Variable Rate Debt should include information about when using non-fixed rate debt is acceptable to the entity either due to the term of the project, market conditions, or debt portfolio structuring purposes.

2. Debt Structuring Practices.

The Policy should include specific guidelines regarding the debt structuring practices for each type of bond, including:

• Maximum term (often stated in absolute terms or based on the useful life of the asset(s)),
• Average maturity,
• Debt service pattern such as equal payments or equal principal amortization,
• Use of optional redemption features that reflect market conditions and/or needs of the government,
• Use of variable or fixed-rate debt, credit enhancements, derivatives, short-term debt, and limitations as to when, and to what extent, each can be used, and
• Other structuring practices should be considered, such as capitalizing interest during the construction of the project and deferral of principal, and/or other internal credit support, including general obligation pledges.

3. Debt Issuance Practices.

The Policy should provide guidance regarding the issuance process, which may differ for each type of debt. These practices include:

• Selection and use of professional service providers, including an independent financial advisor, to assist with determining the method of sale and the selection of other financing team members,

• Criteria for determining the sale method (competitive, negotiated, private placement) and investment of proceeds,

• Use of comparative bond pricing services or market indices as a benchmark in negotiated transactions, as well as to evaluate final bond pricing results,

• Criteria for issuance of advance refunding and current refunding bonds, and

• Use of credit ratings, minimum bond ratings, determination of the number of ratings, and selection of rating services.

4. Debt Management Practices.

The Policy should provide guidance for ongoing administrative activities including:

• Investment of bond proceeds,
• Primary and secondary market disclosure practices, including annual certifications as required,
• Arbitrage rebate monitoring and filing,
• Federal and state law compliance practices, and
• Ongoing market and investor relations efforts.

5. Use of Derivatives.

The Debt Management Policy should clearly state whether or not the entity can or should use derivatives. If the policy allows for the use of derivatives, a separate and comprehensive derivatives policy should be developed.