The National League of Cities recently noted how intergovernmental grants to municipalities are shrinking and becoming more competitive. As a result of this and other factors, local governments have been searching for other ways of obtaining funding, often with mixed results.

Fixed-rate tax-exempt bonds are still in widespread use and reflect the strong market acceptability and interest for this kind of debt product. The type of bond to issue is dependent on a variety of factors.

Public finance experts hold that the municipal bond is still the best method of funding major projects for small and mid-sized cities. Specialists in this field include John Godfrey, a senior government representative at the American Public Power Association; Jason Rittenberg, director of research and advisory services at the Council of Development Finance Agencies; and Paul Jack, a managing director at the investment banking firm Estrada Hinojosa, all of whom offered their insights for newly elected and appointed city officials.

Godfrey explained how the Great Recession has affected the availability of intergovernmental grants.

“Since 2004, discretionary spending has fallen from 7.4 percent of gross domestic product to 6.8 percent of GDP. Discretionary programs are where grants come from, and that pot is shrinking. Also, the Budget Control Act of 2011 cut non-defense discretionary spending by about $490 billion and by another $290 billion under sequestration. Those spending caps still apply and will apply until 2021. Prior to the Budget Control Act, they were expected to spend $650 billion on non-defense discretionary programs. As a result of the act and sequestration, they are going to spend $590 billion for this year.”

Due to these cuts, the process for obtaining federal grants has become even more competitive, which means it is important for cities’ proposals to pay attention to and meet specific grant criteria. Rittenberg stressed this point, saying, “You really need to know the purpose of the program and make sure that your narrative is clearly addressing the purposes of the grant. The people who administer the programs are very willing to have conversations with cities beforehand to let them know what they are looking for. In some cases, you can even get pre-scored, and these agencies will let you know what your scoring might be based on your project or criteria, and that can be really helpful in making sure that you are applying for the right grant.”

The recession has also meant fewer people participating in the labor market, which hampering the willingness to increase taxes. With limitations in the ability to obtain grants and raise taxes, local governments have been exploring different ways of funding their infrastructure projects. Although options such as lease-purchase financing and interest rate swaps may have appeal for some, municipal bonds have a long track record of being a safe and reliable method for funding municipal projects.

Indeed, Godfrey recommends exercising caution when considering certain methods of financing.

“There are a lot of bright and shiny objects out there, a lot of new ideas and new tools that people are proposing to be used. Make certain that you have the expertise to assess whether that makes economic sense for you and your community … [Municipal bonds] are far less complicated transactions than a hundred-year lease where you have the anti-compete clauses or dedicated revenue streams or partial repayments and all these sorts of tensions and flips and twists … But you don’t have to go with the new and fancy product. There’s a pretty good one in the toolbox that has been used for centuries.”

Municipal bonds may be commonplace tools; however, cities typically do not have the requisite knowledge or resources to handle an issuance entirely on their own. It can be a daunting task, even for those who have experience with the bond market. For this reason, Jack underscored the need for conducting due diligence when selecting counsel.

“Small communities are frequently visited by banks and underwriters who offer a multitude of services but who do not have a fiduciary obligation to protect the municipality’s interests both in the short term and long term.

FLOW OF BONDS — BOND SALE: Because of the many moving pieces involved with any financial instrument, including municipal bonds, it’s a good idea for a municipality that’s thinking about issuing one to contract with a professional who can provide advice about the procedure. (Diagram provided by Estrada Hinojosa)

We would recommend that small towns and cities obtain the services of a well-regarded and experienced municipal advisor who can serve as a guide to this complex world. With a qualified municipal advisor on their side of the table, the municipality can make better decisions that will provide the best services to the public at the lowest cost.”

Advisory services are necessary due to the multiple options available in the world of municipal bonds. They can vary by the type of security, such as general obligation or revenue bonds; by the purpose or user, such as public-improvement or private-activity bonds; and by the structure, such as serial or term bonds. Th ese intricacies will necessarily differ according to each municipality’s goals and circumstances.

According to Jack, most cities issue fixed-rate tax-exempt bonds, and this reflects the strong market acceptability and interest for this kind of debt product. The type of bond to issue is dependent on a variety of factors, he added, but mainly based on the revenue source; the use of proceeds; the length of the bond issue; the state of the market and types of investor who will buy the issue; the credit profile of the issuer; and the tax status of the issue.

Qualified counsel is also engaged in helping municipal officials to navigate the regulatory, legal, contractual and internal issues that attend a bond issuance.

“Regulatory limits may involve disclosure-related requirements for the issuer to present in offering documents, as well as limitations for timing and the manner of bond issuance that affect the tax-exempt status of bonds, among others,” Jack said. “Legal limits may reflect state laws that require voter approvals, limit debt issuance based on certain metrics and allow for petition against certain bond issues. Contractual limits may include bond restrictions based on covenants found in resolutions and trust indentures that are part of bond documents. Lastly, internal limits may be imposed by cities such as debt/budget policies and internal coverage requirements.”

Municipal bonds have a reputation for being a safe and reliable
method for funding municipal projects. However, with limitations
in the ability to obtain grants and raise taxes, local governments
are also exploring different ways of funding their infrastructure
projects.

Because of the many moving pieces involved with any financial instrument, Rittenberg recommended cities placing a priority on educating themselves on their options when going into a deal.

“You are going to work with a qualified professional when you do the issuance, but if you can come to the table already having a good idea of what is possible and what some good options are, then you’ll be able to make sure that you are going to do the best job that you can for your municipality.”

Consult the Government Finance Officers Association, the Municipal Securities Rulemaking Board, the Council of Development Finance Agencies or a state municipal agency or other qualified group able to provide the experience and valuable insights needed for navigating the various stages of a bond issuance.