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KeyTermsandPracticesModule3.pptx

Capital Budgeting, Long Term Debt, and Strategic Planning - Key Terms & Practices

Alvin Holliman, DM, CPA (retired/inactive)

Capital Project Budgeting

Long term in nature, usually covering 1 to 5 years but can be longer

Difficult to plan for unless revenue or other funding sources are secure and on-hand

Danger lies in committing to projects that are dependent on inter-governmental transfers, grants, or loans (such as Community Development Block Grants {CDBG}, federal transportation annual grants, etc.)

Secure funding sources often include proceeds from debt financing that was issued solely to fund the specific project(s).

Capital Project Budgeting (continued)

For enterprise funds (water, wastewater, electric utility operations, etc.) the capital budgeting process is typically dependent on either debt financing (revenue bonds) or a build up in reserves for capital replacement, improvement, or expansion.

Enterprise funds account for and budget capital projects within the Enterprise Fund category – not the Debt Service Fund category.

Capital projects are often included in a separate budget document apart from the operating budget but can also be included in the operating budget, often in summary form or as an addendum.

Prior to 2011 in California, a large share of capital projects were funded by redevelopment tax increment and related debt financings. This included extensive affordable housing projects. The California legislature and Governor Brown abolished redevelopment in 2011. However, many other states still allow and encourage tax increment financing.

Capital Project Budgeting (continued)

The capital budgeting process often involves a project “ranking” process as presented by staff and approved by the governing body – usually because funding availability is limited.

Another danger in the capital budgeting process is a change in elected officials whereby new officials do not agree with prior officials’ ranked priorities.

This is particularly problematic if portions of the previously approved projects have already begun. This can also include legal problems.

Furthermore, many projects (nearly all in present-day California) must pass environmental reviews (such as environmental impact reports {EIR’s} and the California Environmental Quality Act {CEQA}. It is very dangerous to commit funds beyond those needed for such planning processes, because the risk of non-approval or mitigation costs can kill the project or exceed funding availability.

Debt Financing

Debt is often incurred or issued for the purpose of constructing, acquiring, or developing capital projects deemed of public benefit by the applicable entity’s governing body.

An underlying public policy presumption of public debt issuance is the length of repayment (terms) should be commensurate to the taxpayer life cycles who “benefit” from the improvements.

In other words, a water utility improvement or expansion that is estimated to last 30 years would justify a debt term of 30 years as future taxpayers would also benefit from the project.

Conversely, a debt issuance to solve a current budget shortfall or cashflow problem would not be appropriate for long term debt financing (a past practice of California from 2005 to 2012) and New York City many times since the 1970’s.

Debt Financing (continued)

Government debt issues are typically referred to as bond issues unless short term lease financing is used for funding short term assets (such as police cars, fire trucks, computer equipment, etc.)

Types of bond issues include:

General Obligation Bonds – in California these require voter approval and the revenue used to repay the bonds comes from assessments on the property tax roles).

Another type of debt that is assessed on the property tax roles is Assessment District (or Property Improvement District) bonds that must be approved by a majority of the property owners within the assessment district – not all taxpayers in a city or county pay for these unless it is a citywide or countywide assessment district bond issue so approved by majority vote.

Debt Financing (continued)

Lease Revenue Bonds – a very common but legally complicated debt structure that, frankly, has been designed to get around voter approval requirements in California. With the abolishment of redevelopment tax increment financing in California, this is now undoubtedly the most common mechanism for financing capital improvements.

Utility Revenue Bonds – commonly used by public utilities to finance utility improvements and paid for from the utility rates paid by customers.

Refundings – a weird term for refinancing bond issues – for example, if a lease revenue bond is being refinanced, the legal term of the bond issue would be, “Lease Revenue Refunding Bonds.”

Debt Financing (continued)

Bond issues are evidenced by a document referred to as an Official Statement. Before the debt is issued in order for potential investors to learn about the issuance and issuer (state, city, water district, etc.) a Preliminary Official Statement is issued.

Bond issues involve a rather large team of professionals in addition to the government staff. These include:

Bond Counsel – an attorney or law firm who helps structure the debt to be in compliance with government regulations

Bond Underwriter – the securities firm who guarantees the sale of the bonds and makes them available in the open market

Underwriter’s Counsel - an attorney or law firm who oversees the debt to help mitigate any risk to the underwriter.

Debt Financing (continued)

Trustee – often a bank who collects the revenue from the issuer to pay the bondholders, usually every 6 months, and makes sure the annual disclosure filings and other regulatory requirements are met.

Financial Advisor – optional player or firm who helps structure the debt issuance. This role is generally required if the bonds are sold in a “competitive” environment whereby underwriters bid on the sale of the bonds and is optional if the bonds are “negotiated” with an underwriter pre-selected. Negotiated bond sales are common for refundings.

Printer – the firm that prints the preliminary and final official statements.

Strategic Planning

Governments need to think and plan strategically just as private sector businesses do.

Key considerations in government financial planning include:

Demographics

Population growth

Crime statistics

Inter-government relationships (particularly regional)

Land use availability

Global economic conditions

National economic conditions

Capital project needs

Strategic Planning

Key aspects of the financial planning process include (obviously) revenue and expenditure planning. It is best to focus on revenue or resources availability first before planning expenditures (one can only spend what one has).

Revenue forecasting involves the property tax base (increases or decreases); the sales tax base and expected new retail businesses or loss of businesses; increase or decreases in vehicle registration fees; projected inter-governmental revenues (be careful); utility revenues and allowable transfers to the General Fund; and fees for services such as park entrance fees, library fees, etc. to name just some.

Expenditure forecasting primarily involves demographic analysis and the related impacts on service levels – public safety services, parks and recreation, planning and public works, administration, etc.

Strategic Planning

Capital Project forecasting is similar to the expenditure planning process except the focus is on the facilities and infrastructure needs (roads, bridges, etc.). In California, it is particularly difficult to plan for capital project financing due to the stringent voter approval requirements.

Revenue, expenditure, and capital project forecasting and planning should all consider external data markers as well, such as CPI, interest rates, state, national, and global political and economic changes, and any potential adverse environmental issues such as water contamination, excessive poor air quality, earthquakes, floods, storms, etc.

Forecasting systems can be complex, using computer modeling which incorporates all internal and eternal possible factors, or they can be simple and tackle factors one at a time and then blend them into one overall projection. Honestly, gut instincts are also often used and tainted by political preferences.