Cities may need to borrow money for a number of different reasons, but it usually revolves around a capital project or equipment purchase. A certain amount of planning is needed to get this accomplished. To begin each council should adopt a debt policy. This policy sets out guidelines such as how much debt or what kinds of debt will be used for various projects. Staff, outside consultants, bond rating agencies and federal regulators can review the policy for an overall understanding of the goals for the community’s debt issuance, retirement and overall fiscal management.
As part of the budgeting process the city should establish the scope of the project(s) or equipment purchases for the year. This examination will determine what existing funds are available, if there are other funding opportunities such as available grants, the timing of the anticipated payments, and an estimate of how much borrowing will be needed. This will also determine what type of borrowing would be most appropriate.
General Obligation Bonds
General obligation debt is authorized to be repaid with the city’s property tax revenue. Two major categories of general obligation debt are based upon the type and size of the project or equipment.
Essential corporate purpose debt is for basic city services such as street repair and construction, solid waste, sanitary sewer and water works construction and repair, equipping of police, fire and ambulance services, nuisance abatement, and a variety of other reasons described in Code of Iowa Chapter 384.24(3). The process to issue essential corporate purpose general obligation bonds is simpler than the process to issue general corporate purpose general obligation bonds. The council must publish a notice of the amount and purpose of the bonds and alert the public of the time, date and place of a public hearing to receive oral and written comments for or against the debt issuance. After this hearing, the council may vote to issue these bonds by a simple majority vote.
General corporate purpose debt is issued for city buildings and recreational facilities. For example, bonds issued to build a new, reconstruct or enlarge a fire station, city hall, community center, swimming pool or park would be considered general corporate purpose as described in Code Chapter 384.24(4). For this type of debt, a 60 percent public approval by election is typically required. The city will want to work with bond counsel to draw up the appropriate paperwork and be aware of the precise processes to notify the county auditor to schedule a bond referendum.
For certain types of general corporate issuances that are smaller, an election on the borrowing may be avoided (Code Section 384.26(5)), but the citizens may petition for a referendum:
- For cities with a population of 5,000 or less, debt issuance up to $400,000.
- For cities with a population between 5,000 and 75,000, debt issuance up to $700,000.
- For cities with a population above 75,000 up to $1,000,000 in debt issuance.
In these cases, the council must publish notice of the amount and purpose of the bond issue and must include a statement that the citizens have the right to file a petition asking for a referendum.
Cities can also issue debt to be repaid by revenue generated from a utility or enterprise activity as described in Code 384, Div. V. This type of debt is typically used for utility projects, such as water or sewer. A hearing and authorizing resolution are required to enter into this type of debt. Revenue debt is not secured by property taxes and does not count against the city’s debt limit. However, revenue debt may be less attractive to investors because it is repaid with utility or enterprise revenue instead of property tax, and therefore generally carries a higher interest rate than general obligation debt.
As a substitute for taking bids and selling bonds at competitive sales, cities may enter into loan agreements with banks or underwriters and may negotiate all the terms of the transaction. Bonds or notes are issued to these lenders as evidence of a city’s obligation under a loan agreement. Except for loan agreements that are payable from a city’s general fund, all the statutory processes and procedures related to the issuance of general obligation or revenue bonds are equally applicable to loan agreements, including the need for a referendum for general corporate purpose projects. The primary value of the loan agreement approach is to make it easier for cities to borrow smaller amounts from local banks without having to go through a public sale of bonds.
In order to enter into a loan agreement payable from the city’s general fund, a city must show that its annual payments on all loan agreements payable from the general fund will not exceed 10 percent of the city’s previous year’s general fund budget amount. Advice from bond attorneys and financial advisors is as important to the loan agreement process as it is to the process of issuing bonds.
Cities can also enter into leases, described in Code Section 364.4 (4). Leases are most commonly used to purchase equipment. In general, lease agreements paid from property taxes are still debt and carry with them some of the same procedural requirements. Lease agreements payable from property taxes count against a city’s debt limit unless the agreement stipulates the payments are subject to annual appropriation action by the city council.
Most bond issues payable from utility or enterprise revenues will have bond covenants or requirements associated with them. One common practice is a requirement that a sinking fund be created and maintained into which funds must be deposited monthly so sufficient funds will be available on principal and interest payment dates. It is also common for investors in revenue bonds to require that a city establish and maintain a reserve fund, often equal to 10 percent of the principal amount of the revenue bonds, which can be drawn on if for some reason the city’s utility or enterprise revenues are not adequate to make a regular payment of principal or interest.
Other Types of Debt
There are other types of debt that cities may issue. A few of the more common types will be listed here, but this list is not exhaustive.
- Tax Increment Financing (TIF) Debt. This is debt that is issued to be repaid from the proceeds of incremental property tax increases found in a TIF district.
- Special Assessment Debt. Cities may levy special assessments against abutting property owners who benefit from improvements to streets, utility or other such infrastructure. The special assessment process is complicated, and a city must work with its engineers and attorneys to carry out this process.
- Road Use Tax Fund (RUTF) Debt. Cities receive RUTF revenue collected by the state, mostly from the tax paid on gasoline purchases. Cities receive a share of this revenue from the state on a per capita basis. Cities can issue debt for street related projects and repay that debt from the road use tax fund.
Bond Attorney: Any time funds are borrowed legal assistance from a bond attorney should be secured to ensure compliance with various federal and state regulations and special reporting requirements.
Debt Limits: There are specific limits set by the Code and guidelines regarding debt with which cities should be familiar. The Iowa Constitution places a limit on the amount of debt a city can incur that is payable from property taxes, called the Constitutional Debt Limit. That limit is 5 percent of the value of taxable property within the city. This limit is based upon 100 percent or actual value of all property within the city that can be taxed, not on the value after the state assessment limitation, or “rollback” is applied. There is, however, no legal limit on the amount of debt a city may have that is payable from city utility or enterprise revenues.
Financial Consultants/Advisors: Depending on the size of the city and the expertise of city staff, some communities use the assistance of financial advisors. These advisors help the council identify opportunities to fund city activities. Analysis of the repayment scheduling of a bond or the advertisements for the sale of bonds are only some of the services available.
Bond Registrars: Many bond issues are purchased by multiple individuals, banks or corporations. Keeping track of these owners to ensure that all principal and interest payments are delivered on time may be above the means of the small city staff. Registrars are usually associated with large banks and can handle multiple customers in this specialized area. Bidding for this service is not required.
Bonds Sold Prior to April 1
If general obligation bonds are sold after the budget public hearing but before April 1, the debt retirement schedule can be certified to the county auditor in order to amend the tax rate published as part of the budget process.
Reminder when issuing debt the prudent person philosophy should be applied: the item built or purchased should last longer than the repayment schedule and borrowing money to pay for operating expenses is unadvisable. There are times when borrowing is necessary, but it must be done within the regulations of state and federal regulations.