The importance of a debt management policy

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Why Develop a Debt Management Policy?

Most local government entities consider issuing debt at some point. (See our page on Types of Municipal Debt.) The amount of debt your jurisdiction issues is an important factor in measuring financial well-being, and proper use and management of debt can yield significant fiscal advantages. But issuing debt also obligates your entity to debt service that is often 30 years or more, so debt can have a significant impact on your jurisdiction's financial condition for an extended period of time and limit the funding available for changing service priorities.

The purpose of a well written debt management policy is to articulate your jurisdiction’s goals with respects to debt, enhance your ability to make decisions on issuing or entering into debt obligations, exhibit a commitment to long-term financial planning that will ensure fiscal prudence and financial stability, and (if issuing debt on the open market) demonstrate to rating agencies and lenders that your entity is well managed and therefore more likely to meet its debt obligations.

Key Components of a Debt Management Policy

There are many components of a successful debt management policy. At a minimum, it should include:

• Scope and purpose
• Uses of debt
• Types of debt permitted
• Debt limitations
• Debt structure and repayment
• Debt issuance practices

In particular, there are several critical decisions to make to ensure accountability and help your jurisdiction achieve its financial goals, as discussed below.

Scope and Purpose

Debt policies typically start with a statement of purpose to explain the overall objective of adopting a debt management policy. As an example, Kirkland’s debt policy states:

The Debt Policy for the City of Kirkland (City) is established to help ensure that all debt is issued both prudently and cost effectively. The Debt Policy sets forth guidelines for the issuance and management of all financings of the City. Adherence to the policy is essential to ensure that the City maintains a sound debt position and protects the credit quality of its obligations while providing flexibility and preserving financial stability.

Uses of Debt

A successful debt management policy must consider when it is appropriate to use debt and for what purpose. Of equal importance is to clarify those circumstances in which your jurisdiction will not use debt.

Long-term debt is most frequently used to finance capital improvements and should never be used to support current operations. Your debt policy should consider the capital improvement plan (CIP) to demonstrate the jurisdiction’s commitment to long-term capital planning.

Key questions to consider:

• When is it appropriate to use debt for capital projects? There are differing philosophies over whether to use a “pay-as-you-go” approach (paying for a project with existing revenues) versus “pay-as-you-use” (issuing debt and paying off the debt over the project’s lifetime). For instance, debt increases the total cost of the asset through interest payments, but it also allows you to save time and build capital projects sooner by borrowing up-front, and spreading out payments over a long time helps smooth out expenses and create a more predictable cash flow. If you choose to use debt, the term of indebtedness generally should not exceed the life expectancy of the facility or infrastructure.
• When should long-term debt be used? For example, you might allow long-term debt only for capital improvements that are included in the capital facilities plan or capital improvement plan, or for capital improvements that will benefit both current and future citizens.
• When should short-term debt or interfund loans be used? Ideally, fund reserves should cover any cash flow problems, but if not, short-term borrowing or lines of credit may be used to cover revenue anticipation proceeds, bond anticipation proceeds, or temporary cash flow shortages. Define if and when interfund loans may be used for short-term borrowing. For instance, you might permit interfund loans only if an analysis of the lending fund indicates excess funds are available and loaning the money will not impact the fund’s current operations.
• What will be the impact on future operating budgets? While debt can pay for up-front capital costs, you should also consider long-term maintenance costs over the project's anticipated life. What will be the impact on the annual operating budget? It is generally advisable to require all debt proposals to identify the future operating and maintenance costs and how they will be paid.

Types of Debt Permitted

Debt management policies should address the types of debt permitted (both short-term and long-term), what each type of debt should be used for, and when it is appropriate to use each form. Using the key consideration points above in “Uses of Debt,” expand the policy considerations to speak to the specific types of debt and borrowing that will be authorized by your entity.

The types of debt can be generally broken down into:

• Short Term Obligations are typically less than 1-3 years, depending on your jurisdiction’s policy decisions, and can be used for a variety of reasons. They are often used as a bridge for the immediate needs of a capital project.
• Assessment/LID Bonds are often used to finance capital improvements that benefit a specific group of property owners.
• Limited Tax General Obligation (LTGO) Bonds, also known as "councilmanic" or "non-voted" debt, are payable from the general fund revenues from current taxes being collected.
• Unlimited Tax General Obligation (UTGO) Bonds, also known as "voted debt," are payable from excess tax levies and subject to 60% voter approval.
• Revenue Debt is used to finance capital improvements and facilities for enterprise activities and repaid from service charges.
• Other Types of Debt include leases, intergovernmental loans, Local Option Capital Asset Lending (LOCAL), and interfund loans.

For more details, see our page on Types of Municipal Debt.

Key questions to consider:

• What is the definition of short-term debt or borrowing? For example, does short-term debt have a term of six, nine, or 12 months? Should you include a category for medium-term debt? (For instance, equipment purchases often require loans from one to seven years.)
• Should your jurisdiction use assessment/LID bonds before revenue or general obligation bonds? Assessment/LID bonds are a good way to assure public equity. This type of debt is repaid by the property owners who benefit from the capital improvement. Including policy language to emphasize the use of assessment/LID bonds whenever possible will demonstrate a commitment to public equity.
• When should limited (non-voted) general obligation debt be used? Because non-voted debt does not require voter approval, it provides a level of flexibility for management to utilize under well-defined circumstances. However, non-voted debt does not have its own revenue stream, so the debt service must come from the regular levy typically received in the general fund. Evaluate the impacts of debt service on the budget. Any potential general fund shortfalls must come from other areas of the budget such as police, fire, and parks. Additionally, there is a limited amount of non-voted debt capacity available (see "Debt Limitations" below), and it is a good idea to consider retaining a portion for emergencies or equipment needs that cannot be funded through GO bonds.

Debt Limitations

The use of debt is governed in part by state and federal laws. State law establishes legal debt limits on the type and amount of debt that can be used by local government, while federal law establishes rules about the tax status of government securities and the process for issuing and disclosing debt obligations.

It is important to understand the state limitations, as they will have a direct bearing on the types of debt that you will use, but federal regulations are much more complex and will require professional guidance from bond counsel and others experienced in this area (see the section below on Debt Issuance Practices).

While your jurisdiction’s maximum debt levels are established by state law, each jurisdiction will have to find its own comfort level and determine its ability to pay for debt service. Some jurisdictions may adopt ordinances or resolutions imposing stricter (lower) debt limits than state law.

Note that revenue debt is not subject to statutory limitations or voter approval, so the debt limits should clarify exactly the types of debt that are being limited.

Key questions to consider:

• What are the projections in your Capital Improvement Program (CIP)? When issuing debt for capital projects, you should always consider the CIP and its projected funding sources. Additional debt limitations above and beyond state statute should take into consideration your CIP projections.
• How much debt can your jurisdiction safely issue? It can be helpful to begin by using debt ratios to compare your city’s maximum debt levels and actual debt burden with those of other local governments. Your ability to repay debt will also be affected by factors such as your tax reliance (property tax vs. sales tax) and level of reserves. To assist in your evaluation, try using tools like the SAO Financial Intelligence Tool.

Debt Structure and Repayment

Debt policies should also address debt structure and general repayment terms, including maximum repayment terms, debt service patterns (such as equal payments or equal principal amortization), and the use of variable or fixed-rate interest.

Key questions to consider:

• When should the debt be paid off? Generally, repayment terms should not be for longer than the estimated useful life of the capital asset being financed, but some lenders require longer terms (such as USDA Rural Development loans). Your policy should have enough flexibility to accommodate these possibilities.
• How should your payments be structured over time? If you get to choose how the payments are structured, should you pay back the debt in equal installments? Should the payments be front-loaded or back-loaded? Should you use equal principal amortization, which means the principal payments will remain the same but the interest payments will gradually decrease? The repayment structure should take into consideration your entity’s specific circumstances, but ideally your policy statement should assure maximum repayment of the principal and avoid excessive interest payments.
• Should your jurisdiction consider variable rate loans? Interest rates are typically fixed, but as certain loan programs dry up, local governments may be looking to public banks for loans that may offer a variable rate option. Discussing this option now will avoid policy conflicts later.

Debt Issuance Practices

Establishing clear and consistent debt issuance practices is critical to a successful bond issue. For medium to large jurisdictions that issue their own debt, your debt policy should address:

• Selection and use of professional service providers (bond counsel, financial advisor, underwriters)
• Criteria for selecting sale method (competitive vs. negotiated, private placement)
• Criteria for issuance of advance refunding and current refunding bonds
• Credit ratings (use, minimum, selection)

Small jurisdictions typically do not issue their own debt but will go through a more limited process typically required by the USDA Rural Development program. If this is the case in your jurisdiction, consider reducing this section of your debt management policy to accommodate this type of limited issuance.

Key questions to consider:

• How will you select professional service providers?
  • For smaller entities with a limited issue such as USDA, the only requirement is to appoint “bond counsel.” Selection of bond counsel should be based upon recognized legal experts in this field.
  • For larger jurisdictions that issue their own debt, the criteria may vary depending on the type of debt (such as GO, revenue, or assessment), so consider setting criteria for each.

  Debt Policy Certification

  The Washington Public Treasurers Association (WPTA) provides a useful Debt Policy Certification Program for members. A WPTA policy review committee will go over your debt policy to make sure it adequately addresses the core policy areas and, if so, certify the policy. Certification provides useful guidance to protect your jurisdiction, as well as reassuring your elected officials and members of the public.

  WPTA strongly recommends certifying the policy before submitting it to your governing body for adoption. WPTA also recommends reviewing and updating your debt policy at least every four years.

  The Association of Public Treasurers of the United States and Canada (APTUSC) also offers a higher-level debt policy certification program that might interest larger jurisdictions.

  Examples of Debt Management Policies

  Below are some examples of debt policies that may be useful, focusing particularly on small and mid-sized jurisdictions.

  Debt Policy Template

  • WPTA Debt Policy Certification Program – Includes sample debt policy template developed for smaller jurisdictions in Washington State

  City Debt Policies

  • Ellensburg Debt Policy (2010)
  • Kirkland Debt Management Policy (2020) – Written in accordance with APTUSC guidelines
  • Monroe Debt Policy (2018)
  • Oak Harbor Debt Policy (2015) – Certified by WPTA
  • Poulsbo Debt Policy (2010)
  • Sequim Debt Management Policy (2016)

  County Debt Policies

  • Kittitas County Debt Management Policy (2015)
  • Mason County Debt Policy (2022)
  • Jefferson County Debt Policy (2020)

  Special Purpose District Debt Policies

  • Birch Bay Water and Sewer District Debt Policy (2016) – Certified by WPTA

  Post Issuance Compliance Policies

  • Kirkland Bond Procedure and Post Issuance Compliance Policy (2020)
  • Yakima County Post Issuance Compliance Policy (2020)

  Recommended Resources

  Below are some useful resources from state agencies, the Government Finance Officers Association (GFOA), and other sources to help you develop a debt policy.

  • Washington Public Treasurers Association (WPTA) Debt Policy Certification Program – Guidance for local governments developing debt policies, including policy guidance, debt policy template, and review process
  • GFOA Best Practice: Debt Management Policy – Best practices on debt structuring, issuance, management, and use of derivatives
    • Small and New Issuer Checklist: Considerations When Issuing Bonds