Best Practices in Debt Management.

• Author: Douglas, Jennifer Ritter
• Position: Statistical Data Included

This article provides examples of the practices of innovative jurisdictions who have examined their debt affordability, lowered issuance costs, and provided greater accountability to taxpayers.

At first glance, measuring efficiency in debt management is not a difficult task. The industry is overflowing with indicators and formulas designed to tell issuers and investors what levels of debt are safe and acceptable. Indicators for median levels of debt per capita, debt service as a percentage of revenues, debt principal repaid within five years, and dozens of others are readily available from rating agencies and other sources.

Yet despite all of these commonly accepted indicators, GFOA still receives daily inquiries from members who want to know how they can better manage debt, how they can lower issuance costs, and how debt policies can ensure greater savings and accountability for taxpayers.

Unfortunately, indicators and formulas cannot effectively answer all of these questions. Debt policies are not a "one-size-fits-all" instrument. There is no magic number for what is an affordable level of debt, nor is there a template of a debt policy that would work for every jurisdiction. Debt levels considered too high for a small, rural city with limited revenues likely would be considered acceptable for a large, growing city with numerous revenue sources. And a debt issuance plan designed for an infrequent issuer that spells out specific regulations on acceptable debt instruments and structures may be considered too inflexible for a frequent issuer.

GFOA acknowledges that each issuer is different, while at the same time, striving to give all issuers a common set of guidelines that will apply across market conditions. The result is a set of recommended practices that is designed to offer guidance, while allowing for flexibility. This article will focus on a few "best practices that conform to GFOA's Recommended Practices.

For the purpose of this article, a best practice is an innovative example of a debt management policy or tool that can be used to assist policymakers in priority setting for capital needs, lowering the cost of borrowing (either before or after the sale), and increasing taxpayer accountability. There can be many definitions of a best practice, but in this context, a best practice is an innovative idea that is, for the most part, more detailed than the general guidelines of GFOA's Recommended Practices. The "best practices" highlighted in this article can be considered as real-world applications of GFOA's "recommended practices." In choosing best practices, replicability and innovation were the primary factors.

How Much Debt Is Too Much?

Undoubtedly the most frequent question that members ask is, "How do I know if my debt is too high?" Indicators from rating agencies and other sources will provide some reasonable guidelines-debt burden is considered high when debt service payments represent 15-20 percent of the combined operating and debt service fund expenditures [1]--and some fairly useless ones--debt burden is considered too high if direct net debt exceeds 90 percent of the amount authorized by state law [2] (state authorized debt caps generally only apply to tax-backed bonds, and as such, can easily be circumvented with other debt instruments).

A primary problem with using indicators alone is that it is difficult for issuers to decide which indicators can give them the best picture of their overall debt capacity. Further questions also can arise as to the basis of those indicators, i.e., are they more appropriately applied to large than small issuers?, were the recommended ratios calculated in strong economic times or during a recession?, and how should the indicators be calculated (for example, should leases be included as debt)? Even if an issuer knows what indicators they would like to target, it can be difficult to incorporate those indicators into an overall debt policy.

Because questions like these are difficult to answer, it is helpful for governments to take a comprehensive analysis of debt affordability, considering numerous indicators and ratios and their overall impact on the financial health of the community. GFOA's Recommended Practice on Analyzing Debt Capacity and Establishing Debt Limits recommends that "governmental issuers undertake an analysis of their debt capacity prior to issuing bonds." By analyzing debt capacity, policymakers can better arrive at an estimate of debt affordability, allowing them to create more accurate capital budgets and spending priorities.

Debt capacity and debt affordability studies come in a wide variety of formats. In the December 1998 Government Finance Review, the director of the debt management division of the Oregon State Treasury wrote about that state's traffic light approach to debt affordability. Using the ratio of net tax-supported debt service to available general fund revenues, the State Debt Policy Advisory Commission proposed a range of capacity targets, ranging from zero to 10 percent. A ratio within the green area (0 to 5 percent) signifies that the state has ample capacity to issue additional tax-supported debt; a ratio in the yellow area (6 to 7 percent) indicates that debt levels are entering a cautionary zone and issuance should be slowed; within the red area (8 to 10 percent), debt levels are approaching capacity and could negatively affect interest costs, bond ratings, and access to capital markets. [3]

State of Florida Debt Affordability Study. Building upon the Oregon model...