Q: Is it safe to say that the General Fund is the sole fund that represents the risk when lending to a Municipality? In my experience, I've seen the General Fund account for about 70-90% of district-wide revenue, but on the General Fund balance sheet, it usually only accounts for 20-30% of district-wide assets (since it does not contain any fixed or long term assets).
A. In many instances, this may indeed be true. In the two municipalities we used in the webcast, revenues from governmental activities accounted for roughly 78% of all revenues for West Linn, Oregon but for only 60% for Calistoga, California. In general, the General Fund dominates all other funds. However, if the municipality includes substantial business-type activities, the relative importance of the General Fund may well decrease.
Q: In terms of a debt service coverage ratio, the General Fund typically does not have any long-term debt or even any short-term debt and therefore typically has no debt service coverage ratio. Should debt service ability (EBITDA) / (CPLTD + Interest Expense) be calculated with emphasis on the district-wide financials?
A. Definitely. All governmental funds and business-type activities are really like divisions within a larger enterprise. Cash moves back and forth depending on which divisions is running a cash flow surplus and which is suffering cash flow problems. Note the frequent variances in net transfers from governmental activities to business-type activities and vice versa. Therefore, it makes sense to approach any debt service estimate on an enterprise wide basis.
Q: What is the difference between general obligation and full faith and credit bonds?
A. In practice there is little difference. Both reflect a municipality’s pledge to honor its obligations. However, a general obligation bond is more specific in that it usually includes a pledge to levy property taxes, if necessary, to meet debt service requirement. No such specific pledge is included in a full faith and credit bond.
Q: In addition to my debt service coverage concern, often I have school districts ask for a State Aid Note. The General Fund typically will show the liability on its balance sheet since it is short term and, therefore, I can calculate some sort of debt service coverage ratio. However, when a school district asks for a bus fleet loan (installment loan), the General Fund may show the principal and interest expense on the income statement, but the asset value of the buses and the corresponding liability will not be on the General Fund balance sheet. So in essence, when I risk rate the General Fund, in my experience, it can be different based on the type of commercial loan requested. Agree?
A: The debt service ratio computations should be conceptually similar. In one instance, the debt service refers only to interest expense and, in the other, to the sum of interest expense and scheduled long-term debt repayment. In either case, the numerator would be cash or near-cash available to service debt. If the principal balance were identical for a short-term note and a long-term installment, the debt service ratio would be greater for the short-term facility than for the long-term facility. However, if you supplement a debt service ratio as a measure of risk with a leverage ratio, then you would need to identify the long-term asset and long-term liabilities in constructing the leverage ratio. The comprehensive statement of net assets will include all long-term assets and liabilities for governmental activities.
With respect to the numerator in debt service ratio computations using General Fund information only, note that the statement of revenues, expenditures, and changes in fund balances allows you to use near-cash amounts in computing cash available for debt service. Referring to this statement for Calistoga, California on page 15 in its Comprehensive Annual Financial Report, the amount of cash available to service debt in 2008 was total governmental funds of $8,812,271 less total governmental expenditures (excluding debt service and capital outlays) of $6,652,711. In effect, the municipality had $2,159,560 of cash or near-cash available to meet 2008 debt service of $391,762 – a coverage ratio of 5.51.
Yet this debt service coverage ratio is really misleading since it does not include business-type revenues, expenses, and debt service requirements. You might consider a debt service coverage as really having three components – one for governmental activities, one for business-type activities, and one that applies to the enterprise as a whole. The enterprise debt service ratio may be more appropriate since municipalities are generally able to transfer cash back and forth between different “divisions”.
Q: In Pennsylvania we have the Government Unit Debt Act, by which the court can require the municipality to raise taxes to repay bank debt. Do you have experience with this type of law, and can we rely on it in the future?
A. I have no experience with such a law but, in today’s environment, I would be very reluctant to rely on such a legal provision. The court may act and direct a municipality to raise taxes, but whether the municipality would do so is another question. Its political will to act could vary greatly. And if a municipality did honor the court’s ruling and increase local taxes, there is the issue of taxpayer reaction and their willingness to honor their new obligations. Further, the municipality may or may not mount a vigorous tax collection effort in the face of taxpayer – and voter - resistance.
Q: Typically I see a portion of the Fund Equity labeled as “Reserved for Debt Service”. Would this number be a legitimate addback to EBITDA (or cash available for debt service)? Or in particular, if they municipality has set up a sinking fund for debt service.
A: There may a couple of things to do. First, examine the balance sheet and see if there is sufficient cash or short-term investments to cover the amount labeled as the reserve for debt service. If the amount has truly been reserved, it should be reflected in the cash account.
In addition, run a cash flow using unrestricted donations and contributions - some of which should represent amounts released from restriction for the payment of debt service - and see if the NFP did generate sufficient cash in the last historical period to cover its debt service.
You could run the numbers forward to project cash available to service debt. In doing so, you would need information about the amount of funds that would be released in the coming period for debt service. If there is no cash on the balance sheet, then there will virtually no cash released - unless some unusual circumstances exist.
I don't think I would do anything with addbacks or with adjustments to EBITDA. It all truly comes out in a cash flow statement.
A. In many instances, this may indeed be true. In the two municipalities we used in the webcast, revenues from governmental activities accounted for roughly 78% of all revenues for West Linn, Oregon but for only 60% for Calistoga, California. In general, the General Fund dominates all other funds. However, if the municipality includes substantial business-type activities, the relative importance of the General Fund may well decrease.
Q: In terms of a debt service coverage ratio, the General Fund typically does not have any long-term debt or even any short-term debt and therefore typically has no debt service coverage ratio. Should debt service ability (EBITDA) / (CPLTD + Interest Expense) be calculated with emphasis on the district-wide financials?
A. Definitely. All governmental funds and business-type activities are really like divisions within a larger enterprise. Cash moves back and forth depending on which divisions is running a cash flow surplus and which is suffering cash flow problems. Note the frequent variances in net transfers from governmental activities to business-type activities and vice versa. Therefore, it makes sense to approach any debt service estimate on an enterprise wide basis.
Q: What is the difference between general obligation and full faith and credit bonds?
A. In practice there is little difference. Both reflect a municipality’s pledge to honor its obligations. However, a general obligation bond is more specific in that it usually includes a pledge to levy property taxes, if necessary, to meet debt service requirement. No such specific pledge is included in a full faith and credit bond.
Q: In addition to my debt service coverage concern, often I have school districts ask for a State Aid Note. The General Fund typically will show the liability on its balance sheet since it is short term and, therefore, I can calculate some sort of debt service coverage ratio. However, when a school district asks for a bus fleet loan (installment loan), the General Fund may show the principal and interest expense on the income statement, but the asset value of the buses and the corresponding liability will not be on the General Fund balance sheet. So in essence, when I risk rate the General Fund, in my experience, it can be different based on the type of commercial loan requested. Agree?
A: The debt service ratio computations should be conceptually similar. In one instance, the debt service refers only to interest expense and, in the other, to the sum of interest expense and scheduled long-term debt repayment. In either case, the numerator would be cash or near-cash available to service debt. If the principal balance were identical for a short-term note and a long-term installment, the debt service ratio would be greater for the short-term facility than for the long-term facility. However, if you supplement a debt service ratio as a measure of risk with a leverage ratio, then you would need to identify the long-term asset and long-term liabilities in constructing the leverage ratio. The comprehensive statement of net assets will include all long-term assets and liabilities for governmental activities.
With respect to the numerator in debt service ratio computations using General Fund information only, note that the statement of revenues, expenditures, and changes in fund balances allows you to use near-cash amounts in computing cash available for debt service. Referring to this statement for Calistoga, California on page 15 in its Comprehensive Annual Financial Report, the amount of cash available to service debt in 2008 was total governmental funds of $8,812,271 less total governmental expenditures (excluding debt service and capital outlays) of $6,652,711. In effect, the municipality had $2,159,560 of cash or near-cash available to meet 2008 debt service of $391,762 – a coverage ratio of 5.51.
Yet this debt service coverage ratio is really misleading since it does not include business-type revenues, expenses, and debt service requirements. You might consider a debt service coverage as really having three components – one for governmental activities, one for business-type activities, and one that applies to the enterprise as a whole. The enterprise debt service ratio may be more appropriate since municipalities are generally able to transfer cash back and forth between different “divisions”.
Q: In Pennsylvania we have the Government Unit Debt Act, by which the court can require the municipality to raise taxes to repay bank debt. Do you have experience with this type of law, and can we rely on it in the future?
A. I have no experience with such a law but, in today’s environment, I would be very reluctant to rely on such a legal provision. The court may act and direct a municipality to raise taxes, but whether the municipality would do so is another question. Its political will to act could vary greatly. And if a municipality did honor the court’s ruling and increase local taxes, there is the issue of taxpayer reaction and their willingness to honor their new obligations. Further, the municipality may or may not mount a vigorous tax collection effort in the face of taxpayer – and voter - resistance.
Q: Typically I see a portion of the Fund Equity labeled as “Reserved for Debt Service”. Would this number be a legitimate addback to EBITDA (or cash available for debt service)? Or in particular, if they municipality has set up a sinking fund for debt service.
A: There may a couple of things to do. First, examine the balance sheet and see if there is sufficient cash or short-term investments to cover the amount labeled as the reserve for debt service. If the amount has truly been reserved, it should be reflected in the cash account.
In addition, run a cash flow using unrestricted donations and contributions - some of which should represent amounts released from restriction for the payment of debt service - and see if the NFP did generate sufficient cash in the last historical period to cover its debt service.
You could run the numbers forward to project cash available to service debt. In doing so, you would need information about the amount of funds that would be released in the coming period for debt service. If there is no cash on the balance sheet, then there will virtually no cash released - unless some unusual circumstances exist.
I don't think I would do anything with addbacks or with adjustments to EBITDA. It all truly comes out in a cash flow statement.