Magazine article Government Finance Review

Interfund Transfers: A Credit Perspective

Magazine article Government Finance Review

Interfund Transfers: A Credit Perspective

Article excerpt

Policies and practices concerning transfers from a municipally owned enterprise fund to the general fund give credit analysts important insights into a city's fiscal and political environment.

In times of economic or financial stress, policy makers often look to outside sources to fill the revenue gap between what the public demands in services and what it may be willing to accept in the form of new taxes. Transferring cash from enterprise funds to general governmental funds is frequently a tempting option to satisfy such revenue requirements. Transfers do not come free of costs or risk, however. Before choosing the transfer option, policy makers should fully explore the long-term implications for all of the affected funds and enterprises. Typically, some form of well-researched, flexible, consistent and well-communicated transfer policy will enhance credit quality. Alternatively, having no specific policy will likely lead to difficulty.

Transfers usually take the form of funds moving from an enterprise to a general fund account. Large dollar amounts are involved in some instances, as in transfers from cities' airport, port and electric-system enterprises; but the issues and concerns apply similarly to cities that own only water or sewer enterprises, where transfers may be on a smaller scale.

Impact of Transfers

Transfers from enterprise funds to general government funds typically allow a city to enjoy a higher level of spending and/or a lower rate of taxation than it would otherwise be able to afford, given its tax base and political environment. In many communities, the primary reason for owning some types of enterprises historically was to transfer profits and subsidize tax rates--a reasonable idea, given the cost savings that can be achieved by financing enterprise infrastructure on a tax-exempt basis. An additional benefit of owning and transferring from an enterprise is the ability to capture revenues from otherwise tax-exempt properties such as state, federal or university facilities that require city services but do not pay city taxes.

In the age of downsizing, belt-tightening and reinvention of government, however, there is growing public sentiment towards delivering services at the least cost possible. Services delivered by municipal enterprises are isolated relatively easily from other city services and can be identified clearly with the cost and benefits of delivery.

In a least-cost environment, transfers are less likely to be viewed as a reasonable idea and more likely to be viewed as an indirect way of taxation. This perspective is found especially among large users of the enterprise services, such as airlines or energy-intensive industries. The mounting regulatory costs associated with operating water or sewer enterprises, as well as the increasingly competitive nature of the electric, port and airport industries, have combined to shine a spotlight on municipal enterprise rates and fees that may have been taken for granted in the past. With few exceptions, therefore, a city that depends heavily on transfers reduces its political and financial flexibility and risks incurring the ire of its customers. From the perspective of the financial community, reduced financial or revenue-raising flexibility ultimately evolves into weakened credit quality.

The Worst Policy Is No Policy

How much is too much? The answer depends on the particular circumstances in each community. For example, if a transfer is made regardless of the impact on an enterprise's competitive position or in lieu of needed capital investment, this can weaken the enterprise's credit worthiness. Likewise, if a transfer comprises too large a portion of a general fund budget and if some events weaken the enterprise's ability to continue raising the level of transfer, this can weaken the credit quality of the community's general obligation debt.

The absolute dollar amount of a transfer can be less important than the method or policy from which it is derived. …

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