Debt Management Policy

Utilizing municipal bonds and other types of debt (including bank loans and lines of credit) to fund public infrastructure is a valuable strategy for Governments to spread the cost of significant long-term assets over their useful life.  It is important to involve all stakeholders in the decision to issue debt and to make sure resources are identified to prepare for the issuance of debt and to address on-going requirements throughout its term.

Various GFOA Best Practices provide a comprehensive overview of the requirements associated with a the incurrence of debt, but it is also recommended that any government or authority considering entering into a debt obligation consult the expertise of bond counsel, disclosure counsel, and a municipal advisor to determine the best course of action for their specific project and to assist with the development of debt management policies.

Debt management policies are written guidelines, allowances, and requirements that guide the process of debt evaluation and debt issuance practices of Governments, including the issuance process, management of a debt portfolio, adherence to various laws and regulations, federal tax compliance, and compliance with post-issuance continuing disclosure requirements.  A debt management policy should improve the quality of decisions, articulate policy goals, provide guidelines for the structure of debt issuance, and demonstrate a commitment to long-term capital and financial planning.  Adherence to a debt management policy signals to rating agencies, lenders, and investors that a Government is well managed and therefore is likely to meet its debt obligations in a timely manner. 

Debt Management Policies should include at least the following:

1. Debt Limits.  Governments should consider criteria for evaluating when debt should be issued and set specific limits or acceptable ranges for each type of debt in their debt policies. Limits generally are set for legal, public policy, financial restrictions, and planning considerations.
   1. Legal restrictions may be determined by:
      • State constitution or law,
      • Local charter, by-laws, resolution, or ordinance,
      • Bond indenture, resolution, trust agreement, lease, or similar document, and
      • Bond referenda approved by voters.
   2. Public Policies will address the internal standards and considerations within a Government and can include:
      • Purposes for which debt proceeds may be used or prohibited,
      • Types of debt that may be issued or prohibited,
      • Relationship to and integration with the Capital Improvement Program, and
      • Policy goals related to economic development, including use of tax increment financing and public-private partnerships.
   3. Financial restrictions or planning considerations generally reflect public policy or other financial resources constraints, such as reduced use of a particular type of debt due to changing financial conditions. Appropriate debt limits can have a positive impact on bond ratings, particularly if the Government demonstrates adherence to such policies over time. Financial limits often are expressed as ratios customarily used by credit analysts. Different financial limits are used for different types of debt. Examples include:
      1. Direct Debt, including general obligation bonds, are subject to legal requirements and may be able to be measured or limited by the following ratios:
         • Debt per capita,
         • Debt to personal income,
         • Debt to taxable property value, and
         • Debt service payments as a percentage of general fund revenues or expenditures.
      2. Revenue Debt levels often are limited by debt service coverage ratios (e.g., annual net pledged revenues to annual debt service), additional bond provisions contained in bond covenants, and potential credit rating impacts.
      3. Conduit Debt limitations may reflect the right of the issuing Government to approve the borrower’s creditworthiness, including a minimum credit rating, and the purpose of the borrowing issue. Such limitations reflect sound public policy, particularly if there is a contingent impact on the general revenues of the Government or marketability of the Government’s own direct debt.
      4. Short-Term Debt Issuance should describe the specific purposes and circumstances under which it can be used, as well as limitations in term or size of borrowing.
      5. Variable Rate Debt should include information about when using non-fixed rate debt is acceptable to the entity either due to the term of the project, market conditions, or debt portfolio structuring purposes (See GFOA Advisory: Using Variable Rate Debt Instruments).
2. Debt Structuring Practices.  The Policy should include specific guidelines regarding the debt structuring practices for each type of bond, including:
   • Maximum term (often stated in absolute terms or based on the useful life of the asset(s)),
   • Average maturity,
   • Debt repayment structure, such as equal annual debt service payments or equal principal amortization,
   • Use of optional redemption features that reflect market conditions and/or needs of the Government,
   • Use of variable or fixed-rate debt, short-term debt, and limitations as to when, and to what extent, each can be used,
   • Considerations for the use of structural features to bolster ratings and credit assessment, such as debt service reserve accounts and bond insurance, and
   • Other structuring practices should be considered, such as capitalizing interest during the construction of a revenue bond project and deferral of principal, and/or other internal credit support, including general obligation pledges.
3. Debt Issuance Practices.  The Policy should provide guidance regarding the issuance process, which may differ for each type of debt.  These practices include:
   • Selection and use of professional service providers, including independent municipal advisors, bond counsel, and disclosure counsel,
   • Criteria for determining the method of sale (competitive, negotiated, private placement, bank loan),
   • Use of comparative bond pricing services or market indices as a benchmark in negotiated transactions, as well as to evaluate final bond pricing results, which is often done by, or in consultation with, a municipal advisor,
   • Criteria for the issuance of taxable bonds,
   • Use of credit ratings, minimum bond ratings, determination of the number of ratings, and selection of rating services, and
   • Primary market disclosure practices and procedures.
4. Debt Management Practices.  The Policy should provide guidance for ongoing administrative activities including:
   • Investment of bond proceeds,
   • Budgeting for and making debt service payments;
   • Continuing disclosure procedures; including annual certifications as required by debt documents as well as those related to ensure compliance with any continuing disclosure undertaking (CDA),
   • Tax law compliance monitoring, including arbitrage rebate monitoring and filing, and • monitoring the use of tax-exempt bond financed facilities for private use,
   • Federal and state law compliance practices,
   • Monitoring outstanding debt for refunding opportunities and establishing criteria for when to pursue a refunding, and
   • Ongoing investor relations efforts.
5. Use of Derivatives. The Debt Management Policy should clearly state whether or not the entity can or should use derivatives. If the policy allows for the use of derivatives, a separate and comprehensive derivatives policy should be developed (see GFOA’s Advisory: Use of Debt-Related Derivatives Products).