There are many options available for acquiring debt and/or investing excess funds. As a result, managing debt and investments can be a complicated process. Generally smaller communities have little experience with bond sales, loans, or investment portfolios and should consult with a professional when deciding to invest or to borrow either through a financial institution or through the sale of bonds. Local governing bodies have a fiduciary (trust) responsibility to manage public resources in a manner that is in the best interest of the community, so any decision to borrow or invest must be made with this best-interest concept in mind.
Though borrowing is an attractive alternative for reducing debt or proceeding with a project or capital improvement that is under funded, an organization should give serious thought to whether it has the capacity to manage debt. Any debt must be planned for and included in the community's financial planning and budgeting.
Long-Term Borrowing (Bonds)
When money is borrowed, legal papers are drawn up that officially record the exchange of money. In the case of an individual and a bank, this exchange involves approving loan papers. When a city borrows money by issuing a bond, the idea is similar, but the process is quite different.
When a city issues bonds, it issues a legal note to an individual, group, or corporation in exchange for money. The note, as issued, promises to repay the money borrowed over a specified period of time. Like loans from a bank, bonds pay interest to those who purchase them from the city.
Bonds are used by cities to finance capital improvements, facilities, or equipment which require long-term financing because of their cost.
Revenue Bonds. Revenue bonds are bonds payable from money earned by charging the users for a particular facility or service. Examples of this might be water or sewer service system, electrical utilities, or public buildings that may be supported from leases or other income. An election is not required, according to state law, before a revenue bond is issued (AS 29.47.250).
General Obligation (GO) Bonds. General obligation (GO) bonds are sometimes refereed to as GO bonds, which are issued by a local government with assurance that they will be repaid by money received from local taxes. The bond is a general obligation of the entire city. The full faith and credit of the city are pledged to pay back the principal and interest. AS 29.47.190 requires voter authorization before GO bonds may be issued.
Before entering into the bonding process, the city must employ the professional help of a bond council, like the Alaska Municipal Bond Bank Authority (AMBBA).
The Alaska Municipal Bond Bank Authority
In addition to the traditional market for municipal bonds, there has been established an Alaska Municipal Bond Bank. The purpose of the bond bank is to act as a financial backer for smaller Alaskan cities which wish to market bonds. The bond bank sells its own bonds on the national money market and then uses the proceeds of the sale to purchase the bonds of Alaskan cities. Because the bond bank is able to receive a bond rating better than most small municipalities, it can borrow money at a lower interest rate, then pass the savings on to Alaskan cities.
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Investing options. Most communities have limited resources available to invest; however, communities should have contingency funds, reserve funds, or excess grant funds that can be invested for a certain period of time without imposing a hardship on the community. If your community has surplus funds it wishes to invest, you should seek professional guidance before making any decisions. There are risks associated with investing, so careful thought must be given to whether a community can afford the risk. Generally, the higher the return, the higher the risk. Any excess funds need to be put to work through investments so that they will grow. It can be confusing to try and figure out the different options but the following factors and background will help in the process
Risk refers to the chance the investor takes of losing money during the time of investment. You may be willing, as an individual, to take certain risks, even large risks in hopes of making a lot of money in a short period of time. However, when investing funds that belong to everyone in the municipality, it is imperative that risks be kept to a minimum.
Liquidity/Flexibility refers to the investor's ability to turn an investment into cash quickly. This is important if the money may be needed for an unforeseen circumstance. Some investments impose heavy penalties if money is taken out before a specified time. Some basic principles governing liquidity/flexibility are:
With these principles in mind, ask, "Will the invested money possibly be needed on short notice?" If so, can the city afford to lose some of the gain on the investment?
Yield/Return refers to the amount of money it will come back to the investor over a given period of time, such as money that is earned in fixed interest or the appreciation of the value of the property. The two basic questions governing investment yield are:
Savings Accounts are the most common way that small cities invest funds. Usually the yield is very low but it is quite easy to access the money. Most cities maintain small savings accounts which are used as reserve accounts. Savings accounts are not considered high yield investments.
Certificate of Deposit (CD) are agreements between the bank and the investor where money is agreed to be left in the account for a specific time frame. In turn, the bank agrees to pay a certain rate of interest. The advantage of CDs are the low risk and guaranteed, higher yield, which is usually higher than the interest paid on a savings account. One disadvantage of CDs is that they offer fixed rates of return during a set time period. Should you withdraw the money before the time period is over (maturity) than a penalty is assessed. They, therefore, have little flexibility.
The Alaska Municipal League Investment Pool (AMLIP) is a non-profit corporation formed by the Alaska Municipal League to provide investment services under the Alaska Investment Pool Act of 1992. The purpose of AMLIP is to provide a safe, high-yield, short-term investment option to maximize revenue for boroughs, cities, school districts and other state government entities. Contact AMLIP for more information on how to join and invest.
There are many other option available for investing, the above mentioned are only a starting point. It is suggested to contact a trusted professional before any investment is made
What are the pros and cons of debt financing?
The pros of debt financing are:
The cons of debt financing are:
Are there any restrictions on how a community may borrow or invest its money?
There are no legal restrictions spelled out in the statutes on how a community may invest its money. There are of course restrictions on how grant funds may be spent and are usually spelled out in the grant agreement. There is an implied restriction in fiduciary responsibility. A municipality should not be investing in high risk ventures. Title 29 of the Alaska Statutes gives incorporated communities the power to invest money in investment pools (AS 29.35.015) and to borrow money and issue evidences of indebtedness (AS 29.35.010(11)). There are, however, restrictions and limitations on how communities may issue and manage bonds (debt). There are numerous types of bonds that the community may have available and these are spelled out in AS 29.46.130-140 and AS 29.47.140-340. As mentioned before, elected public officials have a fiduciary (trust) responsibility to their communities, and investing money or issuing debt that is against the best interest of the community may be a breach of that fiduciary responsibility.
What are bonds?
A bond is a loan that the community promises to pay back to the bondholders. It is different from a bank loan because the bond is sold out on the open investment market to anyone who wishes to purchase a piece of that bond. If you get a 1 million-dollar loan from a bank, for your purposes the bank is the only investor in that loan. A 1 million-dollar bond may have thousands of people who purchase shares of that bond. There are many different types of bonds for different purposes. There are numerous types of bonds that the community may have available. These are addressed further in AS 29.46.130-140 and AS 29.47.140-340.
What is the difference between general obligation bonds and revenue bonds?
General obligation bonds are used for capital improvement projects, such as roads, schools, public buildings, etc. and are paid back through taxes or other sources of general fund revenue. Revenue bonds are used for projects that can generate revenue that can be used to pay back the debt. Examples would be electric or water and sewer utilities, or port or harbor facilities that generate revenue through user fees.
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