The cornerstone of developing a fiscally responsible capital cost management system is a solid debt policy. A debt policy is a formal document governing when, how, for what purposes, and to what extent school districts (or other government agencies) may issue debt. A sound debt policy offers many benefits to schools that want to better manage their capital improvement programs. Districts should engage in competitive bidding for the actual building and site as well, but instituting an effective debt policy can save a school district literally millions of dollars. Debt policy:
helps schools avoid common pitfalls of debt issuance and management;
promotes long–term financial stability;
sends a message of responsibility to taxpayers;
can help schools earn better bond ratings from rating agencies;
enhances regulatory compliance; and
assures that borrowing is done at the lowest cost to taxpayers .
An effective debt policy should be firm but not onerous, flexible but not loose. Elements should include the purposes for which debt may or may not be used and the standards for debt issuance. Many municipalities and local governments have adopted formal debt policies, and there are a number of resources available to school districts seeking to prepare their own.
There is no one “model policy,” since the needs and circumstances of each school district are unique. The following is a set of debt policy elements that are remedies to costly problems, government regulations, or are Wall Street requirements. In addition, some of these recommendations are simple common sense.
Long-term debt should not be used to finance current operations or to capitalize expenses. Operational expenses should be completely covered through the current–year budget. Capital debt should not be used as a credit card to pay for teacher salaries, transportation services, or other recurring school district expenses.
Long–term debt should be used only for capital projects that cannot be financed from current revenue sources. Capital debt should be used only for large “one–time” projects, such as school buildings that will last for decades.
Total district indebtedness should not exceed 15 percent of the district taxable valuation for any given year. The legal debt limitation is 15 percent, though it should be noted that qualified school bonds are exempt from this limit under Michigan law. Qualified school bonds are general obligations of the school district, while they are budgetary (sometimes called “moral”) obligations of the state in the event of default. It is arguable as a matter of local district policy and of honesty to taxpayers and bond buyers that qualified bonds should be included in the limitation. This limitation is a maximum; however, fiscal prudence and the financial situation of the district may warrant a lesser percentage.
Retire 50 percent of the total principal on debt within 10 years. This policy encourages repayment of debt in the shortest possible time without creating undue hardship for the taxpayers. In order to retire 50 percent of the principal within 10 years, the term of the debt should not be more than 16.5 years.
Avoid variable–rate debt and back–loading and balloon repayment schedules. Level or declining repayment schedules incur less interest cost. Delayed repayment schedules, typically used in an over–optimistic expectation of strong long–term growth of the tax base, incur greater interest cost. Delayed or back–loaded repayment schedules also lock future taxpayers into unnecessarily high debt repayment taxes. Variable–rate debt, dependent upon external rates and indices, is arguably a form of speculation.
Bonds should only be re–issued (for the purpose of interest rate savings) under limited circumstances. There should be at least a three–percentage points savings when re–issuing bonds.
Avoid capital leases, certificates of participation, or similar instruments for the acquisition or use of facilities or equipment. This is different from proposal below on leasing buildings. Capital leases (also called certificates of participation) are a form of obligation whereby a government enters into a lease agreement with a third party, usually a private developer. The third party then uses the lease payments as security for obligations (“certificates” or conduit securities) that it issues for the acquisition of the facility or equipment to be leased. The government makes lease payments as a first budgetary obligation and no additional tax is imposed to secure the obligation. Therefore voter approval is unnecessary. But avoidance of voter approval creates suspicion, which is the main source of controversy for capital leases. Also, the government may vacate the lease through non–appropriation, and although capital leases are not considered “debt,” such termination of the lease can have a serious impact on the government’s creditworthiness.
Limit capital fund investment instruments to reliable sources. Government bond buyers demand absolute safety. Investments should only be in U.S. Government securities, local government trusts, or fully insured bank certificates of deposit (CDs).
Issue debt through a competitive bidding process. Competitive bidding can reduce interest costs, and it avoids questions of unfairness and favoritism in the debt underwriter selection process. General obligation school bonds are typically not so complex, and marketing or timing considerations not so critical, as to warrant anything but competitive bidding for most bond issues.
Seek independent debt counsel through formal requests for proposals. This policy prevents conflict of interest and incorporates and exceeds the requirements of Municipal Securities Rulemaking Board Rule G-23 (which permits financial advisor/underwriter relationships if such relationships are disclosed to the issuer).
The district and its financial advisors should comply with all applicable financing and full disclosure reporting rules. Under SEC regulations, full and continuing disclosure is mandatory for issuers of debt. An explicit policy statement stresses its importance to the issuer.
Public funds, property and resources should not be used, directly or indirectly, to influence the outcome of ballot questions. Bond professionals and others should be barred from “pay to play” practices – that is, making political contributions to those involved in the issuance of public debt.