VII. Local Government Borrowings

• Library: Municipal Law Deskbook (ABA) (2015 Ed.)

VII. LOCAL GOVERNMENT BORROWINGS

A. Forms of Borrowings

The world of local government finance is fraught with obscure buzzwords and acronyms. Some describe important differences but others make distinctions that have little practical difference. However, every local government borrowing will have a borrower, a lender, and a set of terms that describe when the borrower is required to pay the lender. If practitioners can translate the buzzwords into common lending terminology, the translation should help practitioners understand many of the most important aspects of a particular local government financing. In an effort to assist in this translation, this section provides the basic meanings of some common terms that practitioners are likely to encounter when dealing with local government borrowings.

"Bond" most commonly refers to a document that is traded in the public securities market and that is a direct obligation of a local government to pay a principal amount, plus interest. "Bond" also often simply refers to a long-term borrowing. A century ago, in many jurisdictions the word "bond" meant a sealed, negotiable instrument that was executed and delivered with particular formality. A bond is like a note in a commercial borrowing. However, in municipal finance a "bond" often refers to a long-term borrowing, and a "note" refers to a short-term borrowing.

"Certificate of participation" also refers to a document that is traded in the public securities market, but "certificates of participation" are indirect obligations of a local government to pay a principal amount, plus interest. "Certificate of participation" usually refers to a document that is issued by a trustee or escrow agent to evidence the obligation of the trustee or escrow agent to transmit debt service payments that the escrow agent or trustee receives from a local government. Certificates of participation are often used when a local government has the authority to borrow money by entering into a lease-purchase agreement or similar obligation, but it does not have the authority to issue bonds in denominations that can be conveniently traded in the public securities market. For example, a city may enter into a lease-purchase agreement to finance a fire truck and related equipment that cost $500,000. If the city enters into the lease-purchase agreement with the vendor of the equipment, the lease-purchase agreement will allow the city to pay the $500,000 purchase price in installments, with interest. Effectively, the city is borrowing the purchase price from the vendor. If the city thought it could obtain more favorable terms from the public securities market, the city could enter into the same lease-purchase agreement with an escrow agent. The escrow agent would prepare "certificates of participation" evidencing the right of the owners of the certificates to receive portions of the principal and interest payments that the city has to pay to the escrow agent under the lease-purchase agreement. The city would arrange for the escrow agent to sell those certificates of participation in the public securities market, and it would transfer the sale price of the certificates to the city. The city would use the sale price of the certificates to pay the vendor to acquire the fire engine and equipment, and it would pay for the fire engine and equipment over time by making the payments due under the lease-purchase agreement.

"Lease-purchase agreement" means an agreement of a local government (often called the "purchaser" or "lessee") with a lender (often called the "seller" or "lessor") to pay principal (often called the "purchase price") over time, with interest, in connection with the acquisition of an asset. The local government will have the right to use the asset while it is making payments, and the asset often can be retained by the lender if the local government defaults.

"Line of credit" is a borrowing, usually with a commercial bank, that allows a local government to borrow money as it is needed, and to avoid paying interest until the money is needed. When a local government issues conventional bonds or notes, the local government borrows the entire amount of the bonds or notes at the beginning and pays interest on the borrowed amount until the borrowed amount is repaid.

"Issuer" means the local...