i.5.1.1 Debt Management Policies

Public agencies develop and apply policies to ensure that debt is issued and managed prudently. This practice is advocated by the GFOA, which published and subsequently updated Best Practice guidelines for debt management policies in 1995, 2003, and 2012.29 The GFOA endorsed the use of a debt management policy to improve the quality of decisions, articulate policy goals, provide guidelines for the structure of debt issuance, and demonstrate a commitment to long term capital and financial planning.

A local agency’s debt management policy can assist its debt managers in making decisions and supporting efforts to identify conflicts, inconsistencies, and gaps in a local agency’s approach to project finance and debt management. A debt policy can also be instrumental in setting a proper balance between limits on the use of debt financing and providing sufficient flexibility to respond to unforeseen circumstances and opportunities. Potential benefits of a formal debt policy include the following:

Supporting financial decisions that are transparent and consistent

Establishing standard operating procedures to guide daily financial activities

Providing performance measures and limits based on predetermined levels and benchmarks

Providing justification for decisions

Providing an interface between capital planning, long term financing objectives, and daily operations

Focusing on the overall financial plan in contrast to individual issues

Proactively safeguarding public agencies from making unsuitable debt related decisions

Providing consistency and instruction to new and transitioning staff

Establishing an effective management mechanism for post issuance compliance

Lacking a formal set of well understood and well communicated policies, issuers may run into problems in both the issuance and administration of debt. In the absence of policies, issuers may fail to control the type, structure, and maturity of debt being issued. They may enter into service contracts that are not well understood and potentially harmful, and they may fail to meet federal disclosure and tax compliance obligations. Failures such as these may result in adverse outcomes for public agencies and their officials. To the extent that a lack of policies leads to the injudicious use of debt, poorly structured debt or repayment schedules, or the failure to meet disclosure or tax obligations, the issuer may be penalized by regulators, downgraded by ratings agencies or, at minimum, lose investor and tax payer confidence.

Equally painful are the implications of a poorly managed debt portfolio to the agency’s fiscal conditions. Potential implications include cash shortfalls, missed debt service payments, or the inability to call or refund debt to take advantage of changing market conditions. Well constructed and well communicated policies protect the interests of the public as well as the public servants who, acting in good faith, seek to meet the needs of their constituents.

TOPICS ALL PUBLIC AGENCIES SHOULD ADDRESS IN THEIR DEBT MANAGEMENT POLICIES

Assignment of Responsibilities – Issuers may depend upon professionals to provide various services associated with debt issuance and administration. But in the end, it is the issuer’s full responsibility to perform these tasks. Issuers are accountable for the information contained in the Official Statement through which the debt securities are sold and in all subsequent disclosures and financial reports and are responsible to pay principal and interest in full when due. Issuers are responsible to use the proceeds for the purposes represented to the investors and to tax and fee payers. Issuers commit to comply with all laws and regulations regarding the administration of the bonds in the contract they execute with the securities dealers. But who is responsible to track whether they have complied with these promises and obligations?

An issuer’s debt policies should assign responsibility for specific administrative tasks to specific roles within the organization. The match between assignment and task should make organizational sense. That means the person with the role should have the authority to execute the responsibilities of the task, the knowledge and resources to do so, and the supervision necessary to make the role accountable. These assignments should be reviewed intermittently and changed when either personnel within the agency change or the scope of responsibilities changes. The agency should adopt procedures to monitor its performance, questioning both whether tasks were performed as required and within an acceptable timeframe. Monitoring can be built into the agency’s internal control program as discussed below.

Public agencies differ in size and staffing. When they lack sufficient expertise or resources, they may contract with service providers to perform administrative tasks related to debt. The agency must continue to dedicate resources to monitoring contract performance and to ensuring compliance.

Identification of Refunding Opportunities – Issuers of fixed rate debt may benefit by refunding outstanding bond issues when interest rates fall. As with a home mortgage, refunding debt allows the borrower to save money. Some state laws authorizing California public agencies to issue refunding bonds include a requirement that the interest rate on the new debt result in debt service savings. The agency’s debt policies should identify who is responsible for making the decision and under what circumstances it is appropriate to refund.

Tax Compliance – In order to maintain the tax exempt qualification, issuers must ensure that the requirements of Section 103 of the Tax Code are met through the life of the bonds:

Filing of certain information at the time of issuance

Proper use of bond financed property

Limitations on investment earnings and how the bond proceeds may be invested

Calculation and rebate of any positive arbitrage

When circumstances arise unexpectedly and cause issuers to fail in their tax compliance, U.S. Treasury regulations provide “self help” remedies that issuers can employ to maintain the tax exemption of the debt. For example, if due to changed circumstances a public agency desires to sell a portion of the property acquired with the debt proceeds, the public agency could redeem or defease the portion of the debt allocated to the property being sold.

Keeping Up with Bond Covenants – Issuers promise investors that certain conditions or practices regarding the bonds will remain in place for the life of the bonds. These may consider the use of the facility by a private business, the issuance of additional bonds in the future, insurance coverage on the financed facility or system, maintenance of credit agreements or maximum tax rates of taxpayers. Each of these, as conditions of issuance, are memorialized in one of the key financing agreements, such as an indenture, lease, or installment purchase agreement. Once agreed to, however, these conditions obligate the issuer to create administrative procedures to test, monitor, and respond to deviations from the agreed upon conditions.

Investing Debt Proceeds – Because an issuer’s debt policies address the issuance and administration of its debt program and compliance with any legal, contractual, or regulatory obligations under it, its investment policies must address the investment of bond proceeds. See Chapter 9 – Investment of Bond Funds. Government Code Section 53601 sets forth the allowable investments a public agency may use when investing surplus funds. However, this section does provide that bond proceeds may be invested differently if invested in accordance with the bond documents. Issuers use this authority to maximize their investment earning, subject to the Tax Code, to potentially increase the funds available for projects or to reduce the size of their debt issuance.