Financial Management Series
Number 5
DEBT MANAGEMENT
Alan Probst
Local Government Specialist
Local Government Center
University of Wisconsin - Extension
Capital Financing Strategy

A Capital Financing Strategy is
essential for any local government to
effectively plan for major projects and
expenditures

Debt Management is one of the key
components of a financial strategy.
Guiding Principles



Borrowing for operating expenditures
is generally unsound
Borrowing for capital projects is
considered essential financial decisionmaking
Borrowing for capital projects requires
effective debt management
Guiding Principles


Effective debt management can
minimize interest costs and even
stabilize local government financial
positions
Periodic review of debt and refinancing when conditions are
favorable are essential to effective debt
management and capital planning
Guiding Principles
Manage debt to borrow for the right
projects at pre-determined
borrowing points that maximize the
government’s borrowing efficiency
State Limitation
Wisconsin Constitution limits
county, municipal, and town
borrowing and other debt to 5% of
equalized taxable property
Local Debt Capacity

Some commonly used ratios can
provide guidance on debt affordability

Ratios allow you to compare your
situation to statewide averages or
similar-sized communities
Common Ratios
For a local government to decide how much
debt it can afford to issue, it must look at
bond and debt ratios. Common ratios are:
 Net debt per capita
 Net debt as a % of taxable or market
valuation
 Annual debt service on net debt as a % of
general fund revenues or spending
Local Debt Capacity

All ratios refer to “Net debt”

Net Debt is debt that is paid for from
general revenues or taxes

Includes General Obligation bonds
Debt Service
The Wisconsin Constitution also
specifics HOW and WHEN local
government debt must be
repaid
Financial Status
Before a governmental body decides to borrow
or sell debt, it needs to determine its
financial status, i.e. whether it can afford to
incur debt

Is the General Fund balance adequate?

How close to the Constitutional debt limits
are you before incurring additional debt?

What is your ability to borrow, such as
bond rating?
General Fund Balance



General Fund balance must be adequate to
ensure continued positive cash flow
A common guideline is to maintain six (6)
months operating expenditures as a reserve
If you have an insufficient General Fund
balance, you cannot be assured of your
ability to continue operations and service
new debt
Debt Limit


By law, you cannot borrow additional
funds if your borrowing will place your
debt beyond the Constitutional debt
limit
If you borrow to your debt limit, you
have no recourse for additional funds
in the case of emergencies
Bond Rating
Bond ratings are an evaluation of the
insurer's credit quality rated by:

Moody’s Investors Service

Standard & Poor’s (S&P)

Fitch Ratings
Bond Rating




Bond rating is determined by your financial
stability and perceived ability to repay debt
A rating of “AAA” is most desirable
Any rating of less than “A” will probably
incur an unacceptable interest rate.
A rating of “C” or “D” effectively places you
in the “junk bond” range
Bond Rating
Your bond rating is influenced by such
factors as:
 General Fund Reserve
 Audit findings
 Revenue projections
 The stability of your local government
 Past payment performance
 State and local policies
Types of Financing

“Pay-as-you-go” Financing

“Pay-as-you-use” Financing

Debt Financing
“Pay As You Go” Financing
Pays for capital projects and acquisitions
from sources other than debt such as
current taxes and revenue; funds from
Capital Reserves; special assessments
or impact fees; and grant revenue from
federal, state, or foundation sources
“Pay As You Go” Financing




Saves interest charges
Capital projects must be evenly spaced
over time
Needed projects have to be delayed
until necessary funds can be
accumulated
Not equitable if the population is
relatively mobile
“Pay as You Use” Financing
Every long-term improvement or
expenditure is financed by serial debt
issues with maturities arranged so that
retirement of debt coincides with the
depreciation of the project
When a projects' useful life finally ends,
the last dollar of debt is paid off
“Pay as You Use” Financing



Avoids many of the problems of “pay
as you go” financing
Everyone pays for the capital
improvements they use
Ideally, all long-lived projects should be
financed by debt that is retired over the
course of the project’s life
Debt Financing

Money obtained by incurring debt and
used to build or acquire capital assets
or other purposes

Debt financing for local governments
comes mainly from the issuance of
long-term bonds or other debt
Debt Financing

Commonly used for capital projects

Issuing debt to finance cash flow needs
or deficits in operating budgets is
sometimes done but should be
restricted to extraordinary situations
Debt Financing
When using debt financing, a Financing
Plan should be set up to show a
project’s anticipated effect on the local
mil rate, the community’s financial
position, and credit rating.
Expenditures



Current expenditures: for goods and
services used within 1 year and
reflected in the operating budget
Capital expenditures: represent fixed
assets that will provide services for a
number of years
Virtually all long-term debt financing is
used to fund capital improvements, i.e.
Capital Financing
Capital Improvement Program
(CIP)

Used to manage capital financing
needs

Identifies capital projects to be funded
over the next five or six years

First year of CIP serves as Capital
Budget
Capital Improvement Program
(CIP)
Serves as a financial planning tool:
1. Establishes priorities that balance
capital needs with available resources
2. Pairs projects with their intended
funding sources
Capital Improvement Program
(CIP)
3. Ensures orderly improvement or
replacement of fixed assets
4. Provides an estimate of the size
and timing of future bond sales
Debt Policy
A written debt policy establishes guidelines for
the use of debt
Specifies:
1.
Maximum amount of debt that can be
issued
2.
Purposes for which debt can be issued
3.
Types of debt that can be issued
4.
Debt maturity structure
Types of Debt
Long-term debt:

General Obligation (GO) Bonds

Revenue Bonds
Short-Term Notes
General Obligation (GO) Bonds



Secured by the full faith, credit, and
taxing powers of the issuing
government
Legally obligate the local government
to assess taxes as necessary to meet
debt service payments
For capital projects that benefit the
community as a whole
General Obligation (GO) Bonds

Limited only by statutory
limitations

Normally require voter approval
Example
A municipality issues a $12,000 General
Obligation Bond to build a state-of-theart community recreation center,
projected to last for 25 years plus,
which was approved in an advisory
referendum
The bond is issued at 4.15% interest over
a 20 year period
Revenue Bonds

Secured by the revenues of the project
being financed

Their credit depends upon the financial
strength of the financed project

Typically do not require voter approval
Revenue Bond
examples
1.
2.
3.
4.
5.
6.
7.
Airport revenue bonds
Hospital or nursing home revenue bonds
Industrial development revenue bonds
Public power revenue bonds
Resource recovery revenue bonds
Sports complex and convention center
revenue bonds
Water and sewer revenue bonds
Other long-term financing
vehicles
Special assessment bonds


Finance capital improvements that benefit a specific
area
User fee levied on property
Tax increment financing bonds


Promotes economic development in a specific area
Paid from the increase in property tax revenues
generated as a result of the economic growth
Short-term notes
Governments may issue short-term notes
which have maturities of less than
thirteen (13) months


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Bond anticipation notes
Tax anticipation notes
Revenue anticipation notes
Grant anticipation notes
Tax and revenue anticipation notes
CAUTION!
If considering whether to borrow between
funds, remember:
 In your local government accounting
processes, you can NEVER cover deficits in
unrestricted fund balances with restricted
funds
 This can be a “go to jail” issue
 You can “borrow” by resolution but must
have a plan for repayment and stick to it
Debt Maturity Structure
Determined by:

Type of project being financed

Financial position of the issuer

Statutory constraints
Maturity Guiding Principle
A bond issue should not exceed
the useful life of the project
being financed
Bonds

A bond is a single security,
typically with a principal amount of
$5,000

A $1 million bond issue consists of
two hundred bonds, each with a
principle of $5,000
Bonds

In a serial bond issue, portions of
the total issue mature at different
times

Most sold in serial form with
maturities between one and fifteen
years or longer
Debt Service

Each year’s debt service must be
included in the annual budget

Commonly under a debt service
fund
Debt Service

Debt service will include and should
identify principle, interest, and fees on
separate budget lines

Do not forget to budget for the annual
fee on bonds
Basic Debt Management
Questions

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Does the project need to be done now or can
it wait for a more advantageous time?
Is our financial condition such that it can
support additional debt service?
What are the current trends with interest
rates?
What is our current bond rating?
What kind of maturity structure is most
desirable at this time?
Sources
“Management Policies in Local
Government Finance,” ICMA University,
5th Edition, 2004
“Capital Budgeting and Finance: A Guide
for Local Governments,” A. John Vogt,
International City/County Management
Association, 2004