Introduction

Introduction

In general, public agencies turn to the capital markets to finance capital improvements and on occasion, working capital needs. When this financing is achieved through the sale or “issuance” of debt, that debt may be issued as a municipal security. “Debt” in a broad legal sense means an obligation one person is bound to pay, provide, or perform for another. In the context of a public agency, “debt” generally refers to a state or local government’s obligation to make payments with respect to borrowed money. Defined in this way, debt has a principal amount (the amount of money to be repaid) and a maturity date (the date on or by which principal must be repaid) and it bears interest on the principal amount until the debt is fully paid. The interest portion compensates the lender for the financial and economic costs and risks that it assumes when entering into the transaction. The repayment generally consists of a portion representing the principal amount of the debt and a portion representing interest paid on the principal. 

The Municipal Securities Rulemaking Board (MSRB), a self regulatory organization that is subject to oversight by the Securities and Exchange Commission (SEC), provides the following definition for “municipal securities:” 

A general term referring to a bond, note, warrant, certificate of participation or other obligation issued by a state or local government or their agencies or authorities (such as cities, towns, villages, counties or special districts or authorities). A prime feature of most municipal securities is that interest or other investment earnings on them are generally excluded from gross income of the bondholder for federal income tax purposes. Some municipal securities are subject to federal income tax, although the issuers or bondholders may receive other federal tax advantages for certain types of taxable municipal securities. Some examples include Build America Bonds, municipal fund securities and direct pay subsidy bonds.1

Public agencies may also borrow funds through other arrangements that do not constitute the issuance of a security. These transactions are usually structured as leases, loans, or lines of credit and are based upon contractual agreements between the public agency (as the borrower) and the lender (usually a financial institution like a bank or other governmental entity). Debt that are not municipal securities may also include public private partnerships and build lease agreements. 

The California Code of Regulations Title 4, Division 9.6, Section 6000 defines debt to mean “a contractual agreement through which a Creditor or Creditors transfers assets or moneys of an agreed value or amount, or rights to beneficial use of assets, to an Issuer in exchange for one or more non cancelable payments, inclusive of an interest component no matter whether it is paid, accrued, or imputed, over a specified period of time, the total present value of which is approximately equal to the value of the assets or rights on or about the time the transfer occurred.”2

A public agency’s debt may be payable from its “general” revenues or “general fund” or it may be payable from a specific source of revenues such as the proceeds of a specific tax or assessment, revenues of a municipal enterprise, or payments made by another agency, which includes leases. 

This Introduction of the California Debt Financing Guide (Guide) provides a framework for public agencies using debt financing to understand their responsibilities to their constituents and to those who have invested in specific public projects. The focus of the Introduction is on debt financing for capital projects, that is, physical improvements including buildings and fixed assets required to provide governmental services such as libraries, schools, and water or wastewater management facilities. Although considered to a lesser degree, the Introduction also applies to debt issued for operating capital such as lines of credit or pension obligation bonds. 

The Introduction is organized around five recommendations the California Debt and Investment Advisory Commission (CDIAC) makes to all public agencies using debt financing:

  1. Understand your public agency. (Section i.1)
  2. Decide whether debt financing is appropriate for your agency. (Section i.2)
  3. Apply the appropriate analysis to the decision to use debt financing. (Section i.3)
  4. Lead the process of issuing your debt. (Section i.4)
  5. Manage your debt after it is issued. (Section i.5)

For each of these recommendations the Introduction provides materials that will help readers—including elected officials, the public, students of public finance, and experienced public finance professionals—understand the scope of a public agency’s responsibilities before, during, and after issuing debt. Within the Introduction readers will find specific references to additional materials contained in the Guide. Chapters 1-9 of the Guide provide the legal and regulatory context for the use of debt financing by public agencies in California. It is designed to answer questions public agency staff and consultants may have regarding a project or a financing that a public agency may be undertaking.