BRADENTON, Fla. — Tennessee is proposing debt management policies that may be some of the strictest ever adopted by a state for use by local governments, according to the state’s financial adviser, who is a former Government Finance Officers Association board member.
The 21-page “Model Debt Management Policy” includes recommendations for cities and counties such as limiting debt maturities to 20 and 25 years, discouraging the use of back-loaded debt, limiting the use of variable-rate debt to 25% of their portfolios, using independent financial advisers, implementing strategies to avoid conflicts of interest, and weighing the risks of using various kinds of debt.
The new policy is expected to also recommend legal limits on the amount of outstanding debt a local government should have as well as minimum standards for short- and long-term credit ratings. Local governments will be able to modify some policies as long as they cite justification for the changes.
The proposed policies were released earlier this week by Tennessee Comptroller Justin Wilson, who is taking public input on them until Dec. 17.
He is expected to discuss the policies with the State Funding Board on Dec. 17. He hopes to implement the policies by early February, a spokesman said.
“I am very troubled by some of the debt-management practices I have learned about since I became comptroller earlier this year,” Wilson said. “Many city and county governments need some help to manage debt so their citizens are not exposed to unnecessary financial risks.”
The recommended policies are at www.tn.gov/comptroller/lf/pdf/20091030DraftModelDebtPolicy.pdf.
The new debt policies come after local governments in the state, particularly small issuers, experienced problems with variable-rate debt and swaps.
Financial difficulties arose as bond insurers were downgraded, the cost of liquidity soared, and some swaps required big termination payments.
In revamping state policies on local governments’ use of debt, Wilson found that some issuers did not have debt management or swap policies in place as they entered variable-rate and swap transactions.
Last month, the Funding Board adopted sweeping changes to the state’s requirements that govern the use of variable-rate debt and derivatives by cities and counties. Those new rules, which took effect earlier this week, require local governments to employ experts and meet minimum outstanding debt requirements, among others.
The Stae Funding Board’s Guidelines on Interest Rate and Forward Purchase Agreements can be seen at www.tn.gov/comptroller/lf/lfsfundbd.htm.
The proposed debt-management policies under consideration may be the most comprehensive of any state, according to Marlin Mosby, a managing director at Public Financial Management Inc., Tennessee’s financial adviser.
“This is probably going to be the most forward-looking or comprehensive set of debt policies that have been proposed by anyone that I am aware of,” said Mosby, who formerly was the finance director for Memphis and a GFOA board member.
Tennessee’s proposed debt management policies were crafted internally and from comments the state received on the new variable-rate debt and derivatives rules, as well as comments from industry experts.
Mosby said the proposed policies also incorporate many of the published debt management recommendations of the GFOA and the International City/County Management Association.
PFM, the largest independent financial advisory firm in the country, has other clients in Tennessee and none have found the state’s proposed new policies unreasonable, according to Mosby.
Blount County Commissioner Wendy Pitts Reeves welcomed the attention the state has focused on debt issued by local governments and said she asked for best management practices or guidelines about the kind of debt local governments should issue.
“I have been really concerned about how much variable-rate debt we’ve taken on as compared to fixed,” Reeves said yesterday. “I’ve also been very concerned about how much back-loaded debt we’re carrying.”
Reeves said the policies proposed by Wilson seem to be addressing both issues and “his guidance should provide a useful measuring tool for all of us at the local level.”
Tennessee issuers were drawn to derivatives and floating-rate bonds, according to a special report this week by Moody’s Investors Service on how the financial crisis is heightening the potential risks of issuers with variable-rate debt and swaps.
Moody’s found that of the approximately 500 municipal issuers with variable-rate debt and swaps it rated, more than two-thirds are located in four states — Pennsylvania with 22%, California with 17%, Texas with 17%, and Tennessee with 13%.
For California and Texas, Moody’s said its percentages primarily reflected the large number of issuers in those states. For Pennsylvania and Tennessee, Moody’s said the high percentages reflected the “relatively permissive state statutes concerning these structures and the promotion of these instruments by various market participants.”
“Tennessee is among the top four states with local governments that have heavy use of variable-rate debt and swaps,” said Moody’s vice president and senior analyst Geordie Thompson. “The way we look at it is to assess additional risks that come into play and managements’ understanding of those risks, and then we incorporate that on an issuer-by-issuer basis.”
Wilson said he remains concerned about the amount of variable-rate debt used by local governments in Tennessee, particularly debt sold by issuers that “don’t appreciate the risk.”
“When a local official tells me that variable debt saves them a lot of money, I sometimes respond that you would also save money most of the time if you didn’t carry fire insurance on your home,” Wilson said in response to Moody’s report. “Our proposed Model Debt Policy would require any community that has a lot of variable debt to focus on the risk.”
Comments on the proposed policies can be sent to Wilson at email@example.com.