Academic journal article The Journal of Government Financial Management

OPTIMAL DEBT MANAGEMENT PRACTICES for LOCAL GOVERNMENT ENTERPRISES

Academic journal article The Journal of Government Financial Management

OPTIMAL DEBT MANAGEMENT PRACTICES for LOCAL GOVERNMENT ENTERPRISES

Article excerpt

Local government enterprises can include public utilities, sold waste management systems, transportation systems and facilities related to recreation and healthcare. Such enterprises are typically accounted for in enterprise funds, which are used to report operations that are financed and operated like private businesses, where trie intent is to recover expenditures completely or partially from income collected through user rates.

Debt per customer (both current and projected) is a key ratio used by credit rating agencies to evaluate an enterprise's creditworthiness. Higher debt per customer can translate to lower credit ratings. For example, the following table shows the 2012 debt per customer medians by rating as published by Fitch Ratings for water and wastewater utilities, the most common local government enterprises:

As the above table shows, the higher-rated utility enterprises have lower debt per customer. With a lower credit rating, investors usually require a higher return (interest rate) on the enterprise's debt due to the additional financial risk and, hence, borrowing is more expensive. Greater debt loads can lead to added pressure to increase user rates to pay the debt and meet coverage requirements. Higher user rates, in turn, can lead to affordability issues. For water and wastewater utilities, Fitch Ratings has stated that it considers rates for combined water and wastewater service higher than 2% of median household income (or 1% for an individual water or wastewater utility) to be financially burdensome. (Fitch, 2007)

With proper debt management practices, finance managers can help keep an enterprise's debt load reasonable and user rates affordable. This article discusses optimal debt management practices for local government enterprises, both before and after debt is incurred.

BEFORE THE DEBT IS INCURRED

Prepare the organization for incurring debt by conforming with best management practices recognized by the industry. The three major rating agencies - Moody's Investors Service, Standard and Poor's and Fitch Ratings - regularly publish materials that cover what they consider to be best management practices for enterprises such as utilities (e.g., long-term planning, financial targets, etc.). Conforming with operational and financial best management practices can help the enterprise earn higher credit ratings and, hence, secure lower interest rates and issuance costs on debt financings.

Have an appropriate mix of debt financing and pay-as-you-go financing. Annual, routine capital items as well as capital items with short asset lives (for example, ten years or less) should normally be funded on a pay-as-you-go basis. Debt financing is typically used for major capital expenditures for assets with long service lives.

User rates would be lowest over the long-term if the entire capital program were funded on a pay-as-yougo basis, since the enterprise would not pay interest and borrowing costs. However, capital programs often have spending curves that can make payas-you-go funding cost-prohibitive to governing bodies and the public due to the short-term effects on user rates. The advantages of debt financing include the following:

* There may be greater fairness to ratepayers since the recovery of the capital project costs can be spread over the life of the debt instrument to match asset utilization (e.g., 30-year repayment schedule, 30-year asset service life).

* The annual cash flow is reduced to the level of debt service over the term of the debt; hence, the enterprise can handle spikes in capital spending.

* If the enterprise is debt-financing an expansion-related project and has implemented growth-related fees such as impact fees, debt financing may provide more time for growth to pay for itself. Impact fee collections can be used to pay for growth-related capital projects or growth-related debt service, thereby lessening the cost burden for existing users who had to fund the growth-related infrastructure in advance of growth. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.