2.2.2.2 Short-Term Debt
“Short term debt” generally refers to either obligations maturing within 1 year of issuance or obligations payable from the fiscal year revenues of the current fiscal year, although the term is also often applied to debt maturing in the 1 to 5 year range. Short term debt is generally issued in the form of notes, which may bear interest at a fixed rate or at variable rates. Interest is generally paid at note maturity, although if the note term is greater than 1 year, an intermediate interest payment date may be included. Short term debt issues are primarily for the following:
- Cash flow borrowing
- Financing for capital assets with short useful lives (e.g., equipment with a useful life of 1 to 5 years)
- Interim financing for capital assets with long useful lives (e.g., a building with a useful life of 40 years)
Cash flow borrowings (e.g., tax and revenue anticipation notes) are useful if public agency revenues or expenses are uneven over the course of its fiscal year. See Section 3.3.4, TRANs and RANs. A local government entity may receive substantial property tax revenue twice per year, state or federal funding dates may be uneven, water or power sales may be highly seasonal, or expenses may need to be incurred in advance of the receipt of corresponding revenues. To better manage cash flow variation over the course of a single fiscal year, the proceeds from the sale of short term debt can be applied to pay current expenses, with revenues received later in the year applied to repay the debt. To provide note holders security, a mechanism is generally established to set aside revenues for the debt payment as available revenues are received.
Financing for short term capital assets, such as vehicles, should match the useful life of the asset. In many cases this means a term of 1 to 5 years. “Interim financing” with respect to long lived capital assets, generally refers to debt obligations with a significantly shorter term than the useful life of the asset. Interim debt is not expected to be paid (and quite often could not be paid) from current revenues when due, either at maturity or by reason of a mandatory tender. Rather, the expected sources for the repayment of interim debt can include the anticipated receipt of a grant from another governmental entity (interim financing notes are usually referred to as grant anticipation notes (GANs)), a gift, or proceeds from the sale of assets. (See Section 3.7.3, Grant Anticipation Notes and Bond Anticipation Notes).
Issuers using interim financing anticipate paying off the debt in whole or in large part with new long term debt. Long term notes issued for this purpose are usually referred to as bond anticipation notes (BANs). The cost of a new building project may be divided into “construction phase” and “permanent” financing, allowing the issuer to reduce costs during capital project construction and achieve greater flexibility with respect to the amount and term of long term financing. This may be valuable if the total construction cost is uncertain. When construction or other short term risk is significant, interim financing can be provided by lenders familiar with the risks and the long term financing can be done when that risk has passed.
Interim debt can bear interest at a fixed rate or at variable rates and interest may be paid at maturity or on intermediate dates. Principal is not generally amortized. Interim financing is commonly refunded or paid upon completion of the financed project’s construction. Interim financing allows a capital project to commence in advance of receipt of the funds that are the ultimate source of funding and is less costly than debt payable over a longer term than is expected to be necessary.
The principal concern for the purchasers of interim debt is the timing and receipt of the funds expected for use as payment and/or the ability of the issuer to refinance the debt. So the “credit” for interim debt is related less to the issuer’s ability to pay the debt from current revenues and assets and more to the issuer’s “market access” to refinance it to avoid a default. The issuer must access the market even if long term interest rates or liquidity and/or credit support costs are higher than expected.