AGENDA #6a

MEMORANDUM

TO:                 W. Calvin Horton, Manager

FROM:            Jim Baker, Finance Director

SUBJECT:       Information About the Process for Issuing Community Bonds

DATE:             March 6, 2002

This memo is in response to a Council member’s question about the process required to issue bonds for capital improvement projects. 

GENERAL BACKGROUND AND AUTHORITY

Local and State governments in North Carolina have authority to issue General Obligation bonds to finance major capital improvement projects, to construct or renovate buildings and to purchase large capital equipment items with a useful life of more than ten years.  The underlying principal for this type of financing is that the public can and should pay for large capital investments over a long time frame in order to spread the cost among citizens and to better match the multi-year benefits of major investments.  This method enables governments to undertake large capital projects without having to pay cash for the projects in at the time they take place.  In North Carolina, General Obligation bonds can be used only for capital expenditures and never for operating costs.

General Obligations bonds are permitted by State law for a variety of purposes such as the construction of public buildings, capital renovations to public buildings, street and sidewalk improvements, purchase of fire trucks, building parks and recreational facilities and greenways, and acquiring open-space.  General Obligation bonds issued by a local or State government require approval by voters through a public referendum. The full taxing authority of a governmental unit is used to repay General Obligation bonds, generally known as pledging the “full faith and credit” of the unit.

DEBT APPROVAL PROCESS IN NORTH CAROLINA

In North Carolina, the issuance of General Obligation bonds (and all other major types of debt issued by local governments) must be approved by the N. C. Local Government Commission which actually sells the debt on behalf of the local governments.  The Commission also issues detailed guidelines for prudent financial management practices for local governments, and requires numerous financial reports from local governments to check compliance with these guidelines.  Through these approval and reporting requirements, the State ensures good, conservative debt management practices.  As a result, both the State and its local governments enjoy a good reputation in debt markets and are generally able to achieve high ratings from bond rating agencies. 

DEBT SERVICE PAYMENTS

General Obligation bonds are normally sold for maturities of twenty years, with declining payments made over the twenty year period.  In a normal debt service of this type, one-twentieth of the principal would be paid each year plus interest payments based on the outstanding unpaid principal balance. For example, if an entity issues $5 million in General Obligations bonds at an interest rate of 5%, the first years payment on the bonds would consist of one-twentieth of the principal amount of $5 million or $250,000 plus interest of 5% on $5 million in unpaid principal or $250,000.  The total principal and interest payment in the first year would then be $500,000.  Payments in successive years would decline each year, with a second year payment of $250,000 in principal and $237,500 in interest payments on the unpaid principal balance of $4,750,000.   Thus annual payments would decline each year by $12,500 until fully repaid in the twentieth year.

The annual cost of debt service for capital projects is typically stated as a property tax rate equivalent, based on the amount of revenue generated by 1 cent of the tax rate for the entity.  For example, for an issue of $5 million in the example above with principal and interests payments of $500,000 in the first year, the tax rate equivalent of would be 1.2 cents based on the estimate that 1 cent will generate about $415,000 in property tax revenues.

Using a normal debt repayments schedule, the cost of a bond issue could be calculated per million dollars of bonds issued, and the tax rate equivalent could be estimated for a given tax year.  If issued at an interest rate of 5%, then the cost of each $1,000,000 in debt issued would be $100,000 in the first year, and decline slightly each year over then 20-year period as explained above.  The tax rate equivalent for next year for the Town would then be about .2 cents (rounded) per $1,000,000 of debt issued.

DEBT LIMITS AND BOND RATINGS

By State law, local governments may issue debt totaling 8% of the total assessed value of its property tax base.  The 8% limit applies to General Obligation bonds and all types of debt outstanding.  Outstanding debt in most governmental units fall well below this limit, and typical ranges from about 1% to 4%, depending on the utility enterprises operated by the unit.

The Town outstanding debt that applied to this limit at June 30, 2001 was $18,705,000 in outstanding General Obligation bonds.  In addition the Town has $4,250,000 in current bonds authorized, but not yet issued.  This total of about $23,000,000 is less than 1% of the Town’s tax base at June 30, 2001 ($3.039 billion).  The Town’s annual debt service cost is about $2.4 million, or about 6% of the current General Fund budget level.  A general guideline by bond rating agencies is that annual debt service is considered to be low to moderate if less than 10% of the annual General Fund budget.

National bond rating agencies assign bond rating to local governments with each issuance of debt.  The Town currently has a triple A (AAA) rating from Moody’s Investor service, the highest rating attainable from Moody’s.  The Town’s rating from Standard & Poor’s is currently double A plus (AA+), the next to highest rating attainable.