Bond issuers require mission outline

State and local governments that issue new bonds or refund existing debt need to know what factors rating companies consider when analyzing tax-supported debt. In general, a service analyzes a municipal issuer’s willingness and ability to pay its debt.

Financial performance is critical to this analysis, determining whether credit factors — management’s strength (or weakness), debt practices and the area’s economy — are favorable or unfavorable. It is also critical because a municipality must remain solvent to provide constituent services and balance its budget.

Credit analysts examine the local economy, the extent of an issuer’s fiscal control, its revenue-raising ability, its record of budget-balancing, use of one-shot revenues, deficit occurrences, short-term borrowing patterns and reserve levels.

More important than year-end figures, however, is a municipality’s degree of financial control: what services it needs to offer and the resources with which it can provide them. The municipality must outline its mission, budgetary responsibilities and its revenue-sharing ability on which financial control largely depends.

Tax and fee increases must be timely as part of an annual budget process. Tax-rate adjustments during crises are traumatic. Municipalities should also avoid relying on a single revenue stream.

Revenue-raising powers and financial control are measured by a municipality’s sensitivity to the local economy. Some revenue sources — personal and business income taxes, sales taxes and fees and charges to industrial or commercial users — are cyclical. Since ad valorem property taxes can be a more predictable revenue source, local governments able to levy and collect them efficiently can manage with a relatively thin cushion of reserves.

Key budget-related indicators include the general fund balance as a percentage of revenues, composition of assets and liabilities and cash position.

Municipalities can correct budget imbalances with one-shot revenues, which are definitely legitimate and raise no concerns if they meet non-recurring expenses. If the budget imbalance is short-term, deferring some expenses might be appropriate. If long-term, the issuer should balance the budget and maintain essential services.

Short-term borrowing is acceptable — even desirable — when, for example, the timing of receipts and disbursements creates legitimate cash flow needs. However, short-term borrowing to fix an accumulated deficit merely continues unbalanced operations and is undesirable.

Financial reserves address contingencies and are imperative in controlling financial position. The actual fund balance should be related to the likelihood of drawing upon reserves. A credit rating need not suffer from a relatively small fund balance if a long-term trend of annual budget surpluses justifies it.

Generally, municipalities should have a fund of at least 5 percent of revenues. But the scope of operations, volatility and predictability of revenue sources and expenditures and history of achieving budget targets may dictate larger or smaller balances.

Large fund balances often, but not always, reflect sound financial management. Overly large balances can lead employees to seek higher salaries and taxpayers to request lower taxes. The fund balance measures financial position, but financial structure is also important.

Finally, although there are no specific requirements for which accounting methods municipalities should use, analysts prefer General Accepted Accounting Principles reporting, because the system allows them to gather financial information quickly and evaluate it comparatively.