🏢Urban Fiscal Policy Unit 7 – Municipal Debt and Borrowing

What's Municipal Debt?

• Represents financial obligations incurred by cities, counties, and other local government entities to fund various projects and services
• Involves borrowing money from investors with the promise to repay the principal plus interest over a specified period
• Enables municipalities to access capital for infrastructure improvements, public facilities, and other essential needs
• Typically issued in the form of municipal bonds, which are debt securities sold to investors in the capital markets
• Differs from other types of debt (corporate or sovereign) due to tax-exempt status and lower default risk
• Plays a crucial role in financing urban development and maintaining the quality of life for residents
• Requires careful management and oversight to ensure long-term financial sustainability and creditworthiness of the issuing municipality

Why Cities Borrow Money

• Finance capital projects that exceed available cash reserves or annual revenue streams
  • Examples include constructing schools, roads, bridges, water treatment plants, and public transportation systems
• Spread the cost of long-term investments over multiple years, aligning the repayment with the useful life of the assets
• Access funds at lower interest rates compared to other financing options due to the tax-exempt status of municipal bonds
• Maintain a stable tax rate by avoiding sharp increases to fund large projects upfront
• Leverage debt to spur economic development, attract businesses, and create jobs
• Address short-term cash flow needs or emergency expenses (revenue anticipation notes or tax anticipation notes)
• Refinance existing debt at lower interest rates to achieve cost savings and improve financial flexibility

Types of Municipal Bonds

• General obligation bonds (GO bonds)
  • Backed by the full faith and credit of the issuing municipality
  • Repaid using general tax revenues or other unrestricted funds
  • Considered low-risk due to the municipality's ability to raise taxes to meet debt obligations
• Revenue bonds
  • Backed by the revenue generated from a specific project or enterprise (toll roads, airports, water utilities)
  • Repayment depends on the performance and cash flows of the underlying project
  • Higher risk compared to GO bonds, but often offer higher yields to compensate investors
• Tax increment financing (TIF) bonds
  • Used to fund redevelopment projects in designated TIF districts
  • Repaid using the incremental property tax revenue generated by the increased assessed value of properties within the district
• Special assessment bonds
  • Issued to finance improvements that benefit specific properties (sidewalks, streetlights)
  • Repaid through special assessments levied on the properties that directly benefit from the improvements
• Conduit bonds
  • Issued by municipalities on behalf of private entities (hospitals, universities, affordable housing developers)
  • Repayment is the responsibility of the private borrower, not the municipality
  • Municipality acts as a conduit to provide tax-exempt status and lower borrowing costs

How Cities Issue Debt

• Municipalities work with financial advisors and underwriters to structure and price the bond offering
• Engage bond counsel to ensure compliance with legal and regulatory requirements
• Obtain credit ratings from agencies (Moody's, S&P, Fitch) to assess the creditworthiness and default risk of the bonds
• Prepare official statements and disclosure documents to provide investors with information about the issuer, project, and risks
• Market the bonds to potential investors through a competitive bidding process or negotiated sale
• Establish a debt service schedule outlining the principal and interest payments over the life of the bonds
• Set up a trustee or paying agent to manage the collection and distribution of bond proceeds and debt service payments
• Ongoing disclosure and reporting obligations to keep investors informed about the financial health of the issuer and the status of the funded projects

Risks and Benefits of Municipal Borrowing

• Benefits
  • Access to capital for essential infrastructure and public services
  • Ability to spread costs over time and align with the useful life of assets
  • Lower borrowing costs due to tax-exempt status and perceived low default risk
  • Potential to stimulate economic growth, attract businesses, and create jobs
  • Flexibility to manage cash flows and maintain stable tax rates
• Risks
  • Interest rate risk: fluctuations in market interest rates can affect the cost of borrowing and the value of outstanding bonds
  • Credit risk: possibility of the issuer defaulting on debt obligations due to financial distress or mismanagement
  • Refinancing risk: uncertainty in the ability to refinance maturing debt at favorable terms
  • Political risk: changes in local government leadership or priorities can impact the support for debt-funded projects
  • Economic risk: recessions or downturns can strain municipal budgets and reduce the ability to repay debt
  • Pension and OPEB liabilities: unfunded obligations for employee benefits can compete with debt service for limited resources

Regulations and Oversight

• Governed by federal and state laws, as well as local ordinances and policies
• Tax-exempt status of municipal bonds is subject to Internal Revenue Code regulations
  • Restrictions on private use of bond-financed facilities
  • Arbitrage rebate requirements to prevent issuers from earning profits on invested bond proceeds
• Securities and Exchange Commission (SEC) enforces disclosure and anti-fraud provisions
  • Rule 15c2-12 requires ongoing disclosure of material events and annual financial information
• Municipal Securities Rulemaking Board (MSRB) sets standards of conduct for brokers, dealers, and municipal advisors
• State and local governments may impose additional limitations on debt issuance
  • Debt limits based on assessed property values or revenue streams
  • Voter approval requirements for certain types of debt
  • Balanced budget mandates and restrictions on deficit spending
• Credit rating agencies provide independent assessments of credit risk and monitor issuer performance
• Auditors and financial advisors help ensure compliance with accounting standards and best practices

Impact on Urban Development

• Enables cities to invest in critical infrastructure that supports growth and quality of life
  • Transportation networks (roads, bridges, public transit) enhance mobility and connectivity
  • Water and wastewater systems ensure reliable access to clean water and sanitation
  • Educational facilities (schools, libraries) promote learning and workforce development
  • Public safety facilities (police stations, fire departments) maintain safe communities
• Catalyzes economic development by creating a favorable business environment
  • Improved infrastructure attracts private investment and job creation
  • Redevelopment projects revitalize distressed areas and spur neighborhood revitalization
  • Convention centers and sports arenas stimulate tourism and entertainment industries
• Addresses social and environmental challenges through targeted investments
  • Affordable housing projects expand access to quality living spaces
  • Green infrastructure (parks, trails, stormwater management) promotes sustainability and resilience
  • Community centers and social services facilities support vulnerable populations
• Enhances the overall competitiveness and livability of cities
  • Modern infrastructure and amenities attract residents, businesses, and talent
  • Improved public services and facilities contribute to a higher quality of life
  • Strengthened fiscal health and creditworthiness enable continued investment in urban development

Case Studies: Municipal Debt in Action

• Denver Union Station Redevelopment (Denver, Colorado)
  • Issued $300 million in revenue bonds to transform a historic train station into a multi-modal transportation hub
  • Catalyzed $1 billion in private investment, creating a vibrant mixed-use district with office, retail, and residential spaces
• PortMiami Tunnel (Miami, Florida)
  • Used a public-private partnership (P3) model to finance a $1 billion underwater tunnel connecting the port to the interstate highway system
  • Improved cargo and cruise ship traffic flow, reduced congestion, and enhanced safety
• DC Water's Clean Rivers Project (Washington, D.C.)
  • Issued $500 million in green bonds to fund a massive stormwater management and sewer overflow control project
  • Reduced pollution in local waterways, improved public health, and created green jobs
• Atlanta BeltLine (Atlanta, Georgia)
  • Utilized tax allocation district (TAD) financing to fund a 22-mile loop of trails, parks, and transit along a former railway corridor
  • Spurred over $4 billion in private investment, created thousands of jobs, and connected 45 neighborhoods
• Detroit's Grand Bargain (Detroit, Michigan)
  • Negotiated a complex debt restructuring plan to exit municipal bankruptcy in 2014
  • Involved contributions from philanthropic foundations, state funds, and pension concessions to protect city assets and retiree benefits
  • Enabled the city to invest in services, infrastructure, and economic development initiatives