Best Practices

Bank Loans and Direct Placements

GFOA recommends that governments, considering the possibility of entering into bank loans, develop policies and procedures related to these debt obligations.

Bank loans, also known as direct placements, are an important tool in a government’s financing toolkit. For purposes of this Best Practice, the term “bank loans” includes fixed or variable-rate loans with defined maturities and loans or lines of credit that have variable interest rates and flexible payment provisions. Bank loans do not include securities that are offered to the public (competitive or negotiated sale), or privately placed with sophisticated investors (private placement).
Potential advantages of bank loans are that the process for execution of bank loans generally is simpler than a bond issue that is marketed to the public market, have lower issuance costs, and fewer ongoing compliance requirements. Additionally, bank loans can often be structured in a manner that more closely conforms to specific project or repayment considerations than is the case with bond issues. However, because bank loans are typically not executed in an environment that is as transparent as the bond market, an issuer may have limited ability to assess whether the proposed interest rate(s), fees and terms are competitive with a publically offered bond issue and typically are of shorter duration.
Governments should develop specific policies and procedures that address the proper legal and financial aspects of using bank loans for their jurisdiction. Governments also should become familiar with the various types of terms used in these financial products. Governments need to know how bank loans are characterized for legal and accounting purposes, including how they are treated in the government’s financial statements, and what types of disclosures should be made about these loans. State and local laws should be reviewed to ensure these financings are within legal limits and the financing is characterized appropriately.

Governments should develop specific policies and procedures that address the proper legal and financial aspects of using bank loans for their jurisdiction. Governments also should become familiar with the various types of terms used in these financial products. Governments need to know how bank loans are characterized for legal and accounting purposes, including how they are treated in your financial statements, and what types of disclosures should be made about these loans. State and local laws should be reviewed to ensure these financings are within legal limits and the financing is characterized appropriately.

Public disclosure of bank loans currently is not required beyond the reporting requirements in the government’s financial statements. However, many market participants have suggested that providing information about outstanding bank loans is necessary to assess an issuer’s outstanding debt obligations and general credit quality.

GFOA recommends that governments, considering the possibility of entering into bank loans, develop policies and procedures related to these debt obligations. When developing these policies and procedures, and when evaluating the various debt alternatives available to it, governments should consult with their municipal advisor and legal counsel. These professionals should be engaged by the government prior to, and throughout, the negotiations for a bank loan. These professionals can assist with making an assessment of proposed structures, terms and pricing.

Some of the questions that should be addressed before a government pursues a bank loan include:

  • Has the government retained outside professionals to help determine the legality and fiscal prudency of a bank loan? 
  • Does the government have the legal authority by state and local statute to enter into the contemplated financing? 
  • Has the government considered or discussed with its professional team the option of issuing bank qualified debt? 
  • From a statutory standpoint, is the bank loan considered to be debt, and if so, does it apply against the government’s debt capacity or other considerations? 
  • Does a bank loan offer a better solution to the issuer’s needs than a financing offered in the public bond markets? What are the terms that best fit these specific borrowing needs (including fixed vs. variable interest rates)?  
  • How will potential bank loan providers be solicited, evaluated and selected? 
  • Is the government using competitive means to obtain a bank loan? How can the government best negotiate the final terms with the selected financing provider? 
  • Has the government thoroughly reviewed and discussed the term sheet of the loan prior to its execution, and does the term sheet have comprehensive information about the loan? 
  • What is the interest rate on the bank loan? Is it fixed for the term of the loan or does it change during the term of the loan? Is the interest rate a variable rate with predetermined interest reset dates or an index upon which it is based? Is the interest rate subject to change if the rating(s) on the issuer change? Can the government manage the risk of an increase in the interest rate, and to what extent? 
  • Is the loan a fully amortizing loan, or does it incorporate a non-amortizing bullet maturity? How is the debt service schedule structured – level or ascending? Can additional debt be incurred by the government, if necessary? If so, what is the formula for determining how much additional debt can be incurred? Is there a coverage ratio requirement in the loan? Are there penalties for prepaying the loan prior to maturity? Are there acceleration provisions? Can the government manage the risk of acceleration? 
  • What are the covenants included in the bank loan, and who within the government is responsible for ongoing compliance? Are there certain covenants that the government will avoid, such as acceleration or cross-default?

Disclosure Considerations 

Amendments to SEC Rule 15c2-12 for bonds issued on or after February 27, 2019 added two additional event notices. As a result, if a government has issued debt on or after February 27, 2019, public disclosure of bank loans or other financial obligations as referenced through a listed event may be required. The disclosure must occur in a timely manner, typically within a few days of entering into the loan. GFOA recommends that, prior to closing on the loan, governments discuss with Bond Counsel or Disclosure Counsel, what will be filed, and who will be doing the filing. See the GFOA Best Practice Understanding Your Continuing Disclosure Responsibilities.

Even if such disclosure is not required (e.g., issuers that issued bank loan prior to February 27, 2019), many market participants have suggested that providing information about outstanding bank loans is advised to assess an issuer’s outstanding debt obligations and general credit quality. In addition, rating agencies treat bank loans akin to a bond issue or other long-term debt and will inquire as to any bank loans the government may have. Without sufficient information about the loan and the government’s plans to comply with all covenants, they may not be able to maintain a rating.

If the government is not subject to the mandatory reporting requirements of Rule 15c2-12, in order to enhance communication to its citizens and other parties interested in reviewing a government’s credit profile, governments should voluntarily disclose information about bank loans similar to what is required under the mandatory disclosure requirement.

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