To smooth out cash flow, a municipality will issue all of the following EXCEPT

Overview

Local government can borrow money in a number of different ways. These various mechanisms for borrowing are either long-term or short-term, and they can be repaid through tax revenues, user fees, or special assessments.

Long-term debt is a commonly used means of financing large capital assets such as infrastructure, buildings, and large pieces of equipment. Issuing debt increases the total cost of the asset through the payment of interest, but it also allows local governments to acquire or build capital assets sooner by borrowing up front for assets that they could not otherwise fund from existing cash resources. By spreading out the debt payments over many years, local governments can also smooth out their expenses and create a more predictable cash flow.

Short-term debt can be used to cover a temporary cash flow deficit or provide for an interim method of financing until long-term borrowing has been secured.

The amount of debt a government may incur is limited by the Washington State Constitution, individual state statutes, and whether the debt is being repaid with tax or nontax revenue sources. Federal law establishes rules about the tax status of government securities and the process for issuing and disclosing debt obligations.

Debt Types

There are three distinct types of debt that can be issued by local government:

• General obligation (GO) debt is secured by the full faith and credit of the local government issuing the debt. The municipality pledges its tax revenues unconditionally to pay the interest and principal on the debt as it matures. If the debt is in the form of a bond, the bond owners have a legal claim on all the general income of the jurisdiction if a default occurs. The limitations on general obligation indebtedness are provided for in chapter 39.36 RCW. See also our page on General Obligation Debt Limits.
• Revenue debt is different from GO debt in its method of repayment. Unlike GO debt, which relies on taxation, revenue debt is guaranteed by the specific revenues generated by the issuer. For example, water districts can issue revenue debt with the revenues from customer water bills guaranteeing the repayment of the debt.
• Special assessment debt is debt repaid from assessments against those who directly benefit from the project the funds have been used to finance. For example, if a special assessment bond is issued to pay for road improvements that benefit a specific subset of the population, the local government will develop an assessment roll (see our Local Improvement District webpage) for those propeties benefitting from the improvement to repay the bond.

Long-Term Debt

Long-term debt is a legal obligation that typically does not mature for more than a decade and often has a maturity date of 30 - 40 years depending upon the debt type. The funding mechanism used by local government to finance long-term debt can vary widely depending upon the capital project.

General Obligation Bonds

General obligation bonds issued by local governments are secured by a pledge of the taxing district’s property tax authority. General obligation bonds have been the traditional form of financing for capital projects such as land acquisition, park development, and transportation projects that are owned and operated by government. There are two basic kinds of general obligation bonds:

• Limited tax general obligation (LTGO) bonds (also called "councilmanic" bonds or non-voted debt), may be issued by a vote of the legislative body. Because the voters have not been asked to approve a tax increase to pay for the principal and interest, general fund revenues must be pledged to pay the debt service on LTGO. It is important to note that LTGO debt does not provide any additional revenue to fund debt service payments but must be paid from existing revenue sources.
• Unlimited tax general obligation (UTGO) bonds (also called voted debt) must be approved by 60% of the voters, with a voter turnout equal to at least 40% of those who voted in the most recent general election. When the voters are being asked to approve the issuance of these bonds, they are simultaneously asked to approve an excess levy which raises their property taxes to cover the debt service payments. UTGO bonds can be used only for capital purposes. Replacement of equipment is not a permitted use (RCW 84.52.056).

For more information on UTGO debt, see Overview of Voter Approval Requirements for UTGO Bonds (2011) by Foster Pepper PLCC. While this document provides a good overview of the process, note that some details may have changed since it was published. For instance, some of the filing deadlines and election certification dates changed in 2015.

Revenue Bonds

Revenue bonds may be issued to finance projects for any enterprise that is self-supporting. RCW 39.46.150 and 39.46.160 provide general authority to local governments to issue revenue bonds. Additionally, RCW 35.41.030 provides separate authority for cities, and RCW 57.20.018 for water-sewer districts.

Revenue bonds are generally used to finance water and wastewater projects, airports, and stormwater systems. Payment for debt service on revenue bonds comes from user fees generated by the capital facility that is being built. The local entity is then responsible for establishing and collecting sufficient revenue (through rates) to retire the debt.

Revenue bonds are not backed by the full faith and credit of the city, and therefore investors consider them somewhat less secure than general obligation bonds. As a result, the interest rate that bond buyers demand may be higher than those on general obligation bonds.

Revenue bonds are not subject to either statutory or constitutional debt limits. However, the bond market does provide an effective limit to the amount of bonds and/or debt issued. If investors do not believe that the project will generate enough revenue to make the bond payments, they will not purchase the bonds or they may require bond covenants to meet lending requirements. A covenant is a local government’s promise to do or refrain from doing something that would jeopardize the entities ability to repay the loan. 

Improvement District Bonds

When a capital project is going to primarily or wholly benefit only a subset of the citizenry, a local improvement district (LID) or road improvement district (RID) can be formed for part or all of the project. LIDs are commonly used for projects such as street improvements, street lights, sidewalks, water and sewer systems, and undergrounding power lines.

Property owners may petition local government to form an LID or RID, or the city or county may adopt a resolution of intent to form an LID or RID. An LID initiated by legislative resolution may be blocked if the property owners who would be paying at least 60% of the cost protest.

An assessment roll is established with each property's assessment being equal to the estimated special benefit to that property. Property owners have an opportunity to pay all of their assessments up front, but normally LID bonds need to be issued to cover at least part of the project cost. Courts have ruled that LID bonds are not general obligations and are not backed by the full faith and credit of the city. For more information, see our page on Local Improvement Districts.

Another form of special assessment debt is the utility local improvement district (ULID). It may be formed in a manner similar to LIDs for the purposes of providing water systems, sewer and storm water systems, and parking garages. The primary difference between the two kinds of districts is that revenue bonds must be issued for ULIDs, assessments must be deposited in a fund to pay off the revenue bonds, and the bonds are backed both by assessments and by utility revenue.

Lease-Purchase Agreements, Conditional Sales Contracts, and Certificates of Participation

Lease-purchase agreements, conditional sales contracts, and certificates of participation (COPs) are other ways in which some local government entities can acquire real or personal property with tax-exempt financing.

Using a lease-purchase agreement, local government makes installment payments to a vendor or a third party investor over time, acquiring the property (if it wishes to do so) at the end of the lease period for a nominal payment.

In a conditional sales contract, the vendor provides the financing, usually reserving the right to repossess the property if local government defaults. Often the vendor will assign its rights to payment and repossession to a bank at some point during the term of the contract.

Certificates of participation (COPs) are occasionally used in connection with leases and conditional sales contracts. They transform a lease or conditional sales contract into a marketable security. The lessor/seller assigns the lease to a trustee. Underwriters sell shares in the lease (COPs) to investors who purchase them for the same reason they purchase bonds. A good example of COPs is the LOCAL program of the Office of the State Treasurer. This program aggregates small purchases by several jurisdictions into a single bond to create volume savings on issuance costs. COPs typically finance purchases of equipment that are too small to individually warrant the cost of issuing a bond, but for which conventional bank financing is too expensive.

Federal and State Government Loans

Government loans are another important source of funds for financing capital projects. Although the number of government agencies that provide loans is diminishing, the Department of Ecology (DOE) and U.S. Department of Agriculture (USDA) are still large providers.

USDA, through its Rural Development Program, primarily provides loans for rural cities and towns to restore deteriorating water supplies and to improve, enlarge, or modify a water facility or an inadequate wastewater facility. In addition, there are a limited number of loans available each year for what the USDA refers to as “community facilities.” These loans are for public safety facilities and/or equipment and public service buildings such as city halls or public maintenance facilities in rural areas.

DOE provides loans for water pollution control facilities and activities through its Centennial Clean Water and State Revolving loan fund programs.

Refunding and Advance Refunding Bonds

Refunding bonds are bonds that are issued to replace and refinance outstanding general obligation or revenue bonds (chapter 39.53 RCW). The use of a refunding mechanism is often driven by the desire to lower interest rates and reduce payment amounts on older, more expensive debt. Department of Commerce provides updates on refunding activity through the Bond Users Clearinghouse.

Refunding bonds is a procedure whereby an issuer refinances an outstanding bond issue by issuing new bonds. These bonds may be issued if interest rates have fallen since the bonds were originally issued, or if the bonds have restrictive covenants that a local government wishes to remove or modify. The proceeds of the new bonds are either deposited in escrow to pay the debt service on the outstanding obligations, when due, or they are used to immediately retire the outstanding obligations. The new obligations are referred to as the “refunding bonds” and the outstanding obligations being refinanced are referred to as the “refunded bonds” or the “prior issue.”

Advance refunding refers to the practice of issuing refunding bonds more than 90 days before the date on which the refunded bonds may be called and redeemed. Mechanically, the proceeds of the new bonds (the “refunding bonds”) are deposited with an escrow agent, who uses those proceeds to pay the old bonds (the “refunded bonds”) at the earliest possible date (the maturity or earliest “call” date). In certain economic conditions, this can produce a savings by paying off older high interest rate debt with lower interest rate debt, even with a long escrow. It can also be advantageous if there is a need to restructure or alter bond covenants or other restrictions.

For more guidance, refer to GFOA's Refunding Municipal Bonds best practice.

Under changes made to the federal tax code effective January 1, 2018, bonds issued for the purpose of advance refunding outstanding tax-exempt bonds (i.e., more than 90 days in advance of the maturity or call date) may no longer be done on a tax-exempt basis. Outstanding tax-exempt bonds may still be advance refunded on a taxable basis. The economics of a proposed advance refunding on a taxable basis should be reviewed with the issuer’s financial advisor and bond counsel to determine if it makes sense.

In addition, outstanding taxable bonds may advance refunded on a tax-exempt basis. And the municipal bond market has also begun to develop other strategies (sometimes called “forward delivery” or “Cinderella” bonds) for refinancing bonds more than 90 days in advance of their maturity or call date. Issuers should consult with their bond counsel and/or financial advisor about these and other strategies for reducing the costs of outstanding higher interest rate long-term debt.

Private Activity Bonds

Private activity bonds (also known as the Bond Cap Allocation Program, see chapter 39.86 RCW) are tax-exempt revenue bonds often issued by public development corporations formed according to RCW 39.84.030 to finance non-governmental activities. The purpose of these bonds is to finance activities or projects that satisfy a substantial public purpose. They are often used to facilitate economic and industrial development, increase employment, and finance housing.

In Washington State, bonds may only be issued by authorized governmental entities, so a private business developing a project typically works with either a state or local bond issuer. The bond issuer then applies to the Department of Commerce for authorization to issue the bond. Commerce is responsible for taking applications, evaluating projects, authorizing bond issuances under the cap, and ensuring the state does not exceed its cap authority permitted under federal law.

Short-Term Debt

Short-term obligations are used to cover a temporary cash flow deficit or provide for an interim method of financing until long term borrowing has been secured. Short-term borrowing is typically for time periods of 12 months or less. Short-term borrowing includes, but is not limited to, the methods below.

Interest-Bearing Warrants

A warrant is an order that directs the treasurer to pay a specified amount to the named person or the bearer of the warrant. If the city lacks the money to pay the warrant, the treasurer registers the warrant for future payment and is authorized to set an interest rate. Until the warrant is redeemed, the individual or institution holding the warrant is lending funds to the city in an amount equal to the value of the warrant. Because they are backed by the full faith and credit of the city, warrants are general obligations. If they are not paid within the fiscal year in which they are issued, they are considered debt for debt limit purposes.

TANs, BANs, RANs, and GANs

TANs (tax anticipation notes), BANs (bond anticipation notes), RANs (revenue anticipation notes), and GANs (grant anticipation notes) are four short-term borrowing alternatives that are available to Washington local governments. These short-term obligations are repaid out of money derived from the source or sources in anticipation of which they were issued or from any money otherwise legally available for this purpose.

TANs must be paid off no later than June 30 following the year in which they are issued. RANs are similar to TANs except that they are backed by non-tax revenue. TANs, BANs, and GANs are general obligation debt and are subject to the debt limit provisions. Notes issued in anticipation of non-tax revenue bond receipts are not subject to any debt limit.

Lines of Credit

Lines of credit provide an alternative to anticipation notes. A bank and a city agree on the maximum amount that will be available under the line of credit. The local government provides a note to the bank that is backed by the full faith and credit of the jurisdiction. The amount of outstanding principal drawn against a line of credit counts against the debt limits.

Recommended Resources

• Governing Institute: Bond Issuance Guide for Small & Mid-Sized Municipalities (2017) – Useful handbook discusses how bond procurement works, best practices for bond issuance, municipal bond insurance, and regulatory outlook
• GFOA Public Policy Statements – Tax Exempt Financing and the Municipal Bond Market
• GFOA Best Practice: Bank Loans and Direct Placements
• Department of Commerce: Bond Users Clearinghouse

Which of the following would be found in a municipal bond resolution?

Which of the following describes a bank qualified municipal issue?

Which of the following are primary sources of information about the municipal secondary market?

Which of the following statements are true regarding municipal brokers brokers?