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F inancial policies are fundamental elements of strong financial management in state and

local governments. Written policies provide document resources and practices of agreed-upon financial objectives. Debt management policies, like all financial policies, should provide a foundation that promotes consistency in decision making and the achievement of long-term goals. Accordingly, comprehensive debt management policies should identify debt management objectives and preferred risk tolerance, determine what types of debt may be incurred and what structural features are ideal, outline methods of debt sale, and establish procedures for selecting professionals.

A debt management policy offers several advantages. First, it can help community leaders integrate the issuance of debt with other long-term planning. This is especially important because market conditions and plans frequently change over time. A policy can establish core values, goals and financial and management objectives independent of circumstantial changes that would alter a plan. Second, it frames and streamlines the decision-making process before any decisions need to be made, making it easier to remain true to core values and long-term objectives under stress. Third, it provides guidance to community leaders on acceptable levels of indebtedness. Fourth, it can help in educating the community about the debt issuance process. Fifth, once bonds are issued, it is useful in evaluating the impact of each issue on the jurisdiction’s overall financial position. This is valuable since debt

capacity is limited and governments must make each dollar count.

A carefully crafted and consistently applied debt management policy is regarded positively when evaluating a jurisdiction’s creditworthiness. A

debt management policy provides evidence to the rating agencies of your commitment, as a community, to prudent borrowing practices, thereby protecting and enhancing your bond ratings. Credit analysts for credit reporting agencies look at four main categories when determining a credit rating for a city: debt burden, management, financial performance and economic base. Debt burden is an assessment of the community’s ability to support existing and planned debt obligations, using as indicators key financial ratios. Management is a review of the organization and the powers of the government’s administration and the services for which they are responsible. Financial performance is an analysis of revenue and expenditure trends and the adequacy, dependability and scope of revenues. Economic base is an evaluation of the economic outlook for the jurisdiction, focusing on income, population, employment, diversity, composition of employers

and real estate values. Debt burden and compliance with it can easily be measured by comparing the debt management policy requirements with existing debt structures as outlined in the city’s most current “Comprehensive Annual Financial” report.

A debt management policy provides the foundation for a well-managed debt program, helping to ensure that debt is issued prudently and is affordable. It also provides the following benefits:• Provides guidance to community leaders to avoid exceeding acceptable levels of indebtedness and risk.• Directs staff on objectives to be achieved, both before bonds are sold and for

the ongoing management of the debt program.

• Facilitates the debt issuance process by making important decisions ahead of time.

• Promotes objectivity in decision making and limits the role of political influence.

• Promotes general awareness and understanding within the community by listing the types of securities used, defining them, and stating what they enable the issuer to do.The city of Webster Groves

has enacted debt management policies in an effort to standardize and rationalize the issuance and management of debt. The City’s primary objective is to establish conditions for the use of debt and to create procedures and policies that minimize the City’s debt service and issuance costs, retain the highest practical credit rating, and maintain full and complete financial disclosure

DEBT MANAGEMENT POLICIESBy Joan Jadali

20 / November 2012 The Missouri Municipal Review www.mocities.com

and reporting. The policies apply to all general and limited obligation debt issued by the city of Webster Groves, including: bonds, notes, leases, debt guaranteed by the City, and any other forms of debt.

Regularly updated debt management policies are an important tool to ensure that city resources are used to meet its commitments, to provide needed services to the citizens of Webster Groves, and to maintain sound financial management practices. The Debt Management Policy of the city of Webster Groves focuses on four core areas: creditworthiness objectives, purposes and uses of debt, debt standards and structure, and debt administration and process. Creditworthiness Objectives as a whole should be evaluated because they comprise the essentials of how an issuer is viewed in the market. These objectives are broken down further among credit ratings, financial disclosure, capital planning and debt limits. Credit analysts for credit reporting agencies look at four main categories when determining a credit rating for a city: debt burden,

management, financial performance, and economic base, so it is extremely important to demonstrate your entity’s strengths in these areas and to determine how to highlight those strengths in your policy.

Purposes and Uses of Debt define those items that qualify debt-funded projects, as well as asset lives and debt guarantees. It is important to present clarity on the entity’s plan for debt issuance. Does the entity normally rely on internally generated funds and/or grants and contributions from other governmental entities or agencies to finance its capital needs? Is debt issued for a capital project when it is an appropriate means to achieve a fair allocation of costs between current and future beneficiaries or in the case of an emergency?

Debt Standards and Structure defines the length or maturity of debt as well as the debt structure. It identifies the types of debt that will be allowed, such as fixed rate debt, variable rate debt, subordinate debt, derivatives, Bond Anticipation Notes (BANs), Tax Anticipation Notes (TANs) and conduit debt. The

use of credit enhancement such as letters of credit and bond insurance also are noted. The goal is to achieve the lowest net cost given the market conditions, the urgency of the project, and the nature of the security used.

Local governments must take into account a broad range of legal, policy and financial objectives in the process of structuring a bond offering:• What legal or statutory

constraints must be met through the structuring and sizing process?

• What financial or policy objectives must be met through the structuring and sizing process?

• Are there structuring criteria imposed by the rating agencies or credit enhancer?

• Are there particular structures that can result in lower overall financing costs? For example, can certain structural features produce savings because they are attractive to particular investor groups?

• How will the new debt be integrated into the outstanding debt portfolio?

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By offering answers to these questions in a written debt management policy, governments can protect themselves from a number of legal, policy and financial complications.

Debt Administration Process deals with the city’s process for selling bonds in both competitive and negotiated sales, as well as requirements for underwriters and bond counsel.

Recently, concerns about misunderstanding debt transactions, corruption and excessive costs have lead some state and local governments to hone in on the duties of those responsible for debt-related issues. Their debt management policies now contain reporting, transparency and accountability requirements under either a code of conduct section or a similar conflict of interest provision. Some states have gone a step further and passed legislation mandating debt management policies. For example, since Jan. 1, 2012, all public entities incurring or issuing public debt in Tennessee have been required to have a debt management policy on record with the state. The goal behind the mandate is to promote understanding of debt transactions, explain to citizens what is being considered, avoid conflicts of interest, and disclose all costs and risks. As such, an acceptable policy must address transparency, conflicts of interest, professionals (disclosure of their compensation), and specific justifications for deferring principal repayment. Tennessee also strongly recommends creating a maximum level of debt; specific parameters for variable rate debt; a process for decision making and debt issuance; a procedure for managing and monitoring debt; and a plan for regular review of the policy.

Debt management policies, however, should be sufficiently flexible to permit governments to take advantage of market opportunities or to respond to changing conditions without jeopardizing essential public services. For example, many debt management policies recommend fixed rates as opposed to variable rates. The predictability of a fixed rate enables an entity to accurately predict future financial needs and obligations and issue debt accordingly without exposing itself to unnecessary risks. In addition, fixed rates ensure

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that the community members’ expectations regarding their financial responsibilities are met. Nevertheless, variable rate debt can be a valuable borrowing tool in certain economic climates. It can reduce the overall cost of debt by providing flexibility, and for that reason it should be at the government’s disposal should the right circumstances arise. Accordingly, a well-drafted debt management policy would outline a protocol to follow when seeking to exceed policy limitations or employ financial tools that are generally avoided. Debt management policies are, therefore, guidelines for general use, and must allow for exceptions in extraordinary conditions.

For more information on debt management policies, please visit the website for the Government Finance Officers Association at http://www.gfoa.org. Resources: Best Practice. Debt Management Policy (1995 and 2003) (DEBT) found online at http:/www.gfoa.org [Click on “Best Practices and Advisories" on left-hand side of screen.]

Joseph, J. (1994). Debt Issuance and Management, A Guide for Smaller Governments, Government Finance Officers Association.

Kurish, J.B. & Tigue, P. (2005).

An Elected Official’s Guide to Debt Issuance, Second Edition, Government Finance Officers Association.

Tigue, P. (1998). A Guide to Preparing a Debt Policy. Government Finance Officers Association.

Joan Jadali is the director of finance and ad-ministration for the city of Webster Groves. Currently she serves as the past presi-dent of the GFOA of Missouri. For more in-formation, contact her at 314-963-5323 or via email at jadalij@webstergroves.org. Joan wishes to thank Bob Ballsrud with Gilmore and Bell for his assistance, insight and guide-ance in completing this article.