Frequently Asked Questions
There are many options available for acquiring debt and/or investing excess funds. As a result, managing debt and investments can be a complicated process. Generally smaller communities have little experience with bond sales, loans, or investment portfolios and should consult with a professional when deciding to invest or to borrow either through a financial institution or through the sale of bonds. Local governing bodies have a fiduciary (trust) responsibility to manage public resources in a manner that is in the best interest of the community, so any decision to borrow or invest must be made with this best-interest concept in mind.
What are the pros and cons of debt financing?
The pros of debt financing are:
The cons of debt financing are:
Are there any restrictions on how a community may borrow or invest its money?
There are no legal restrictions spelled out in the statutes on how a community may invest its money. There are of course restrictions on how grant funds may be spent and are usually spelled out in the grant agreement. There is an implied restriction in fiduciary responsibility. A municipality should not be investing in high risk ventures. Title 29 of the Alaska Statutes gives incorporated communities the power to invest money in investment pools (AS 29.35.015) and to borrow money and issue evidences of indebtedness (AS 29.35.010(11)). There are, however, restrictions and limitations on how communities may issue and manage bonds (debt). There are numerous types of bonds that the community may have available and these are spelled out in AS 29.46.130-140 and AS 29.47.140-340. As mentioned before, elected public officials have a fiduciary (trust) responsibility to their communities, and investing money or issuing debt that is against the best interest of the community may be a breach of that fiduciary responsibility.
What are bonds?
A bond is a loan that the community promises to pay back to the bondholders. It is different from a bank loan because the bond is sold out on the open investment market to anyone who wishes to purchase a piece of that bond. If you get a 1 million-dollar loan from a bank, for your purposes the bank is the only investor in that loan. A 1 million-dollar bond may have thousands of people who purchase shares of that bond. There are many different types of bonds for different purposes. There are numerous types of bonds that the community may have available. These are spelled out in AS 29.46.130-140 and AS 29.47.140-340.
What is the difference between general obligation bonds and revenue bonds?
General obligation bonds are used for capital improvement projects, such as roads, schools, public buildings, etc. and are paid back through taxes or other sources of general fund revenue. Revenue bonds are used for projects that can generate revenue that can be used to pay back the debt. Examples would be electric or water and sewer utilities, or port or harbor facilities that generate revenue through user fees.
Though borrowing is an attractive alternative for reducing debt or proceeding with a project or capital improvement that is under funded, an organization should give serious thought to whether it has the capacity to manage debt. Any debt must be planned for and included in the community's financial planning and budgeting. The Department of Community and Economic Development's (Commerce) "Local Government Handbook" chapter on "Managing City Finances" has a good discussion on borrowing and bond sales. The Alaska Municipal Bond Bank Authority (AMBBA) has information and assistance available on bond sales and borrowing, as do other public and private organizations.
Most communities have limited resources available to invest; however, communities should have contingency funds, reserve funds, or excess grant funds that can be invested for a certain period of time without imposing a hardship on the community. If your community has surplus funds it wishes to invest you should seek professional guidance before making any decisions. The "Local Government Handbook" chapter on "Managing City Finances" has a good discussion on investing, and there are public and private organizations available to provide assistance with investment. There are risks associated with investing, so careful thought must be given to whether a community can afford the risk. Generally, the higher the return, the higher the risk.
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