In looking at finances for the city we always look at expenditures and working within the budget. We also look at revenues outside of taxes. Both of these to minimize the impact of the tax levy. And then there is managing obligations you have already committed to. By this I mean debt service.
So what is debt service? For most people this is the monthly mortgage or car payment. In the realm of governments it’s the payment on debt incurred on bonds. Cities incur debt to accomplish public improvements. Typically these are road, utility and building projects. Almost without exception all cities incur debt to better their communities.
Incurring debt means there is a repayment, otherwise known as debt service. The repayment on bonds is accomplished over the life of the bond which can range up to thirty years but typically most bonds are 10 to 20 years. With a mortgage you can generally pay off the debt at any time. With a bond you have a “call”. A call is the opportunity to pay off the bond at a point in the future. You call the bonds so you can pay them off. When a bond is structured the call is usually set about half way through the life of the bond. After that point you can pay off the bond. Prior to that, you are bound to the terms of the bond (loan) at the interest rates and payment schedule that was set.
With the recent historic low interest rates in the market, the opportunity to refinance debt has been on everyone’s minds. With bonds, if you have reached the call date it is a relatively easy process to do a refunding (refinancing) of the bonds. What happens however if you haven’t met your call date? You still have the opportunity to do something but the process gets a bit more complicated.
What is done is called a Cross-Over Refunding, sometimes called an advanced refunding. What is done is we sell bonds ahead of the call date to refinance the bond after the call date but in the process you also assume enough debt to cover the payments on the bond you’re refinancing. An escrow fund is established to manage that period of time while you have both bonds outstanding. In doing so you have a short term impact of higher debt but at the call date one bond is paid and the new bond takes over. The point of all this is to reduce your overall long term costs with lower interest rates, and smaller debt service requirements.
Recently the City of Breezy Point accomplished a Cross-Over Refunding taking two bonds and rolling them into one, taking the opportunity to save money in debt service. Before a bond can be refinanced it needs to meet certain criteria in terms of savings. The preliminary analysis showed the criteria were met. At the outset the savings were estimated, over the life of the bonds, to be $255,000. At the time of the sale the savings increased to $290,226.53.
Accomplishing the task was well worth it. The savings won’t be materialized until after the call date but at that point the city is in a position to see reductions in annual debt service requirements.
