How Local Governments Borrow

Let's Dive into how Local Governments Get Money for Big Projects

If we are looking to put on a new roof, or a new addition to our house, or even purchase a new vehicle, we will often go to the bank and take out a loan. Our credit reports will be run, and legal documents will be signed and hopefully, we have our loan to get that new car or new kitchen.

Local government borrowing, isn’t quite as simple as going down to the bank and taking out a loan. Instead of bankers looking at an employment history and credit scores, institutional lenders look at tax rates, population growth and other data points to see if communities are a good credit risk. Today, our newsletter will dive into some of the complexities of local government borrowing.

Local government borrowing in Ohio is a multifaceted process that involves a variety of financial instruments and legal frameworks. Ohio’s local governments, including school districts, have access to several tools for financing public projects and managing their fiscal responsibilities. Today will delve into the primary methods of this type of borrowing in Ohio, with a focus on general obligation bonds, bond anticipation notes, and other financial instruments.

Long Term Borrowing Tools

General obligation (GO) bonds are one of the most prevalent and significant tools for municipal borrowing in Ohio, especially for long term projects. These bonds are backed by the full faith and credit of the issuing municipality, meaning the local government pledges to use its taxing power to repay the debt. GO bonds are considered secure investments due to their backing by the municipality's taxing authority. In many instances, they require voter approval, especially for larger projects or when they exceed certain debt limits. Due to their perceived security, GO bonds often carry lower interest rates compared to other forms of municipal debt.

Local governments in Ohio typically employ GO bonds to finance long-term capital projects such as infrastructure improvements, school construction, public facilities, and parks and recreation projects. The security and relatively low interest rates associated with GO bonds make them an attractive option for funding substantial, long-term investments in community infrastructure and amenities.

Short-Term Borrowing Options

On the other hand, bond anticipation notes (BANs) are short-term debt instruments that local governments use to provide immediate funding for projects, with the expectation of issuing longer-term bonds in the future. BANs typically mature within one year, though they can be renewed. They serve as bridge financing, providing quick access to capital while the local government prepares for a larger bond issuance. This flexibility allows the borrowing entity to take advantage of favorable market conditions for short-term borrowing. Tipp City is currently investigating using these tools to purchase the Tipp Plaza Shopping Center, in the community’s uptown business district.

The BAN issuance process begins when a local government identifies a need for immediate funding. BANs are then issued to cover the initial costs, while the municipality plans for a future bond issuance to repay the BANs. Eventually, long-term bonds are issued to retire the BANs. This process allows borrowing communities to begin projects quickly while spreading the long-term cost over an extended period.

Other Borrowing Tools

Ohio’s local governments also have access to several other borrowing instruments to meet their financial needs. Revenue bonds, unlike GO bonds, are secured by specific revenue streams such as utility fees, toll collections, or special assessments. These bonds do not typically require voter approval and do not count against a local government's general debt limits, providing an alternative financing method for projects with dedicated income sources.

Tax Increment Financing (TIF) is a method of financing improvements in a designated area by capturing the increased property tax revenue resulting from those improvements. While not a direct form of borrowing, TIF can be used to secure bonds or other debt instruments, making it a valuable tool for targeted development projects.

The Ohio Water Development Authority (OWDA) and Ohio Public Works Commission (OPWC) offer loan programs that provide funding alternatives for specific types of projects. OWDA provides low-interest loans to Ohio communities for water and wastewater infrastructure projects, while OPWC loans fund various infrastructure projects. These loan programs often offer favorable terms compared to market-rate borrowing, making them attractive options for municipalities undertaking eligible projects.

A Complex Regulatory Environment

Ohio's municipal borrowing practices are governed by a complex set of laws and regulations. The primary legal framework is provided by Chapter 133 of the Ohio Revised Code, known as the Uniform Public Securities Law. This law outlines the rules and procedures for issuing local government debt in the state.

Ohio’s local governments face various debt limitations, including direct debt limits typically set at 5.5% or 10.5% of the borrowing entity's assessed property valuation, depending on the type of debt. There are also indirect debt limits based on voted and unvoted debt. These limitations help ensure fiscal responsibility and prevent excessive borrowing by local governments.

The issuance of local government debt in Ohio generally involves a multi-step process. This includes identifying the need for borrowing, obtaining necessary approvals (such as voter approval for certain GO bonds), preparing official statements and other required documentation, marketing the debt to investors, and finally closing the transaction and receiving funds.

Several factors influence a community’s ability to borrow and the terms of that borrowing. Credit ratings from agencies like Moody's, S&P, and Fitch play a crucial role, with higher-rated communities generally able to borrow at lower interest rates. Market conditions, including prevailing interest rates and overall economic conditions, significantly impact the cost of municipal borrowing.

The nature and expected lifespan of the project being financed influence the choice of borrowing instrument and terms. For instance, long-term infrastructure projects might be better suited to GO bonds, while short-term cash flow needs might be addressed with BANs.

A community's overall financial condition, including its budget balance and existing debt load, impacts its borrowing capacity and terms. Fiscally healthy local governments with strong financial management practices often enjoy more favorable borrowing conditions.

Bringing it all Together

Ohio’s local governments have a diverse array of borrowing tools at their disposal, enabling them to finance essential projects and manage their fiscal responsibilities effectively. From general obligation bonds to specialized loan programs, these instruments provide flexibility in addressing various funding needs. However, communities must navigate a complex legal and financial landscape, balancing the need for capital with fiscal prudence and regulatory compliance. As economic conditions and community needs evolve, Ohio's local government leaders must continually assess and utilize these borrowing tools judiciously to serve their constituents and maintain fiscal health.

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