Memorandum

City of Lawrence

Finance Department

TO:	David L. Corliss, City Manager
FROM:	Ed Mullins, Finance Director
Date:	July 27, 2012
RE:	Debt Issuance Guidelines

Background

The City Commission adopted the current debt service policy in 2002.  Included as part of the policy were a set of debt issuance guidelines that listed certain ratios and levels that were based upon averages for similarly rated cities or upon desired levels.  These guidelines were not meant to be maximums that could not be exceeded, but rather as an early warning that exceeding them to a large extent could possibly result in a downgrade of the city’s debt by our rating agency as well as requiring the city to devote more resources to servicing debt.

The rating agencies look at several factors in rating a city’s debt.  Moody’s bases their ratings on Economic Strength (40%), Financial Strength (30%), Management and Governance (20%), and Debt Profile (10%).  Standard and Poors bases their ratings on Institutional Framework (10%), Economy (30%), Management (20%), Financial Measures (30%), and Debt Profile (10%).  Both rating agencies place a larger emphasis on the economy and management then on existing debt outstanding, although some of the financial measures also include debt payments.  Currently, the city only requests a rating from Moody’s.

Rating Factors

Lawrence faces overall challenges in its debt ratings because of lower per capita income and relatively low market value per capita.  These measures are the result of a large number of students and the fact that the University of Kansas is exempt from property taxes.  However, having a large stable institution is also viewed as a positive by the rating agencies.  In Moody’s rating dated September 6, 2011, it listed strengths as a history of market access, stable financial operations with sound reserve levels, and a significant institutional presence.  The challenges included reliance on sales tax revenue and slow tax base growth.  Factors that could improve Lawrence’s rating were a significant expansion of the tax base and improvement in resident incomes.  Factors that could lower the rating were a decline in reserve levels and deterioration of the tax base.  A future concern is the level of pension funding and other post employment benefits.

Proposed Changes

Since the city’s guidelines have not been revised since 2002, they were reviewed and compared to current averages.  A table showing average financial ratios by Moody’s debt rating for Kansas and U.S. cities was obtained from Springsted.  Moody’s has also changed the definition of the debt ratios since the guidelines were developed in 2002.  As a result, the proposed guidelines have been modified so that the ratios follow the Moody’s definitions more closely.  The ratios are considered by Moody’s as part of the Debt Profile Factor. 

Moody’s uses the term direct debt to include all debt supported by a property tax pledge.  This includes bond anticipation notes (temporary notes) since they will ultimately converted to long term debt.  Their definition also includes bonds paid by sales taxes provided the sales tax debt is secured by a general obligation pledge and the proceeds are used to fund a facility related to a typical general government function.   Net direct debt is defined as direct debt less general obligation debt supported by enterprise revenue such as water and sewer charges.   Moody’s definition of direct debt also includes capital leases.

A table showing the revised guidelines and values as of December 31, 2011 is attached.  Most of the guidelines were developed to approximate the averages for Aaa rated cities in Kansas.  Also attached is a projection of the guidelines including future debt issuances.  The issuances include financing for the library, farmland and recreation center infrastructure, downtown parking, and a new Quint in addition to the capital improvement projects proposed by the City Manager.  The projection indicates that the city will be at or below the proposed ratios.  

Recommendation

It is recommended that the City Commission adopt the revised Debt Issuance guidelines.