Types of Bonds
In general, there are three major types of local government bond offerings commonly used in Montana. These include:
The type of bond issued to finance a communities improvements depends on the circumstances surrounding the bond offering. The following pages briefly describe each of the major bond types.
General advice on the preparation of a bond issue may be obtained from the Montana Association of Counties (406-442-5209) or the Montana League of Cities and Towns (406-442-8768). These local government organizations may provide assistance on technical or legal matters at little or no cost to the community. In addition, these organizations may be able to supply lists of recent debt offerings within the state as examples.
Revenue Bonds
Community-wide sewer and water projects are most often funded by revenue bonds. Revenue bonds pledge the revenue from a particular source (such as the water or sewer system which is being constructed or improved) to meet the principal and interest payments. The bonds are issued without the guarantee of the "full faith and credit" of the issuing local government. The amount of debt a community takes on by issuing revenue bonds is not subject to limitations on bonded indebtedness by Montana law.
a. Purpose and Usage
Revenue bonds pledge the monies obtained from a particular revenue source to meet the principal and interest payments of the bond issue. One of the primary purposes for which revenue bonds may be issued is for the acquisition, construction, or improvement of water and sewer systems [7-7-4402(3a) through 7-7-4404, MCA].
b. Issuing Procedures
Procedures for issuing revenue bonds are similar in most respects to the provisions for issuing general obligation bonds. The primary difference is that revenue bonds may be issued through a resolution of the governing body, and no election is required. Revenue bonds are not subject to the debt limitations that are imposed for general obligation bonds. The governing body, at its own discretion, may submit the question of issuing bonds to the voters for approval but this is not required. If the issue is submitted to voters, the election must comply with the same provisions which govern general obligation bond issue elections.
Any facility or project financed through the use of revenue bonds is required to be self-supporting. The local government must prescribe (and revise, when necessary) the appropriate fees or service charges to insure the undertaking remains self-supporting. The fees or service charges must be sufficient to pay all principal and interest costs of the bonds, must provide for operation and maintenance costs, and must provide adequate reserve funds. The proceeds from the sale of bonds must be applied only to the bond issue for which it was intended, and transfer of funds to any other account is prohibited.
The method by which revenue bonds may be underwritten may also vary from that commonly used for general obligation issues. Revenue bonds are commonly underwritten on a competitive basis, whereby underwriter bids are solicited and selected based on which bid has the lowest borrowing costs. State statutes impose limits on several revenue bond provisions for the protection of the issuing government. The final maturity may not exceed 40 years from the date of issue.
Legislation enacted in 1999 allows water and sewer districts to create a hybrid form of revenue bond that combines aspects of a special improvement district bond. Under this new alternative, the water or sewer district can levy special assessments in the same manner that cities can under the SID process. The bonds issued by the district are denoted as revenue bonds but are repaid by special assessments against property within the district that are benefited by the water or sewer improvements. The bonds must still be approved by the voters of the district. The statute (Section 7-13-2221, MCA) sets out the process that must be followed in establishing the assessment methodology and in levying the assessments. As with conventional SID's, the proposed bond issue is subject to protest procedures by affected property owners.
c. Advantages and Disadvantages of Revenue Bonds
i) Advantages
The major advantage of using revenue bonds over other bond types is revenue bonds are paid for by the users of the facilities being financed. This feature of revenue bonds constitutes the most equitable method of debt repayment for local citizens and assures the facilities will be self-supporting through user fees or service charges. Use of revenue bonds by local government is also advantageous due to the fact that the debt is not subject to Montana limitations on bonded indebtedness and that a bond election is not required. The credit analysis required for revenue bond issues is more straightforward because payment generally comes from only one source and an analysis of the economic health of the entire community is not necessary. However, the legal and financial protection of the revenue bonds does require close scrutiny. In the event of default, local taxpayers are not burdened with the debt repayment. Another advantage of revenue bonds is they can be used to finance projects extending beyond municipal boundaries. Generally speaking, revenue bonds may be supported by a pledge of revenues received from operations in any legitimate service area, whether inside or outside the geographical limits of the borrowing governmental unit. Use of revenue bonds allows needed improvements to be undertaken, even if the locality has reached its legal debt limit or taxing limit for general obligation bonds.
ii) Disadvantages
Interest rates are typically higher and the market not as diverse for revenue bonds because revenue bond issues are generally repaid through monies generated by the public facility and are not backed by the unlimited taxing powers or the full faith and credit of the issuing government. The legal requirements for issuing revenue bonds are more complicated than for general obligation bonds due to the fact that restrictive covenants are often attached to the bond which restrict facility operations. Since Montana statutes require use of revenue bonds be limited to self-supporting projects or facilities, user fees or service charges may need to be revised several times over the life of the bond issue. Increases in charges may encounter opposition from the users of the system. Most revenue bonds have call provisions that allow the issuing government to retire the debt before final maturity or refinance the project. The call feature of many revenue bonds may deter some investors.
General Obligation Bonds
General obligation bonds pledge the unlimited taxing power and the full faith and credit of the issuing government to meet the required principal and interest payments. The amount of general obligation debt a community can issue is limited by Montana statutes. These bonds are most often used to finance capital projects which benefit the entire community over a long period of time (generally 20 years). One authorized purpose for issuing bonds is for the construction of sewers, sewage treatment and disposal plants, or water works [7-7-4101(2), MCA]. An election is required to obtain voter approval prior to the issuing process. The bond issue election is caused by the presentation of a petition signed by a percentage of voters (usually 15%) or by the unanimous agreement of the governing body.
a. Purpose and Usage
The traditional means of financing most large, non-revenue producing capital improvements projects, such as public buildings, health facilities, or recreational facilities in Montana communities has been through the use of general obligation bonds. These bonds may be issued by local government to finance projects that benefit the entire community for a long period of time. Montana statutes identify the major purposes for which municipalities or counties may incur indebtedness. State statutes limit the amount of general obligation debt a community may incur a percentage of the local government's taxable valuation. This percentage varies for counties, municipalities, and consolidated city-county governments.
b. Advantages and Disadvantages of General Obligation Bonds
i) Advantages
Since the issuing government pledges its unlimited taxing power and its full faith and credit, general obligation bond issues are considered to be secure investments. This fact makes general obligation bond offerings attractive both to underwriters and other investors; however, interest rates on these bonds are frequently lower than other bond types. The primary advantage of issuing general obligation bonds over other bond types is that non-revenue producing projects may be financed over long periods of time. Projects funded through the sale of these bonds generally benefit the entire community for periods of twenty years or more. The outstanding debt is retired over the life of the project from a form of taxation equitable to all residents. Any revenue remaining in the sinking fund after principal and interest payments have been made may be invested and used to retire the debt prior to final maturity. Since voter approval is necessary prior to the issuance of general obligation bonds, the expense is generally acceptable to local citizens.
ii) Disadvantages
The extent to which general obligation bonding may be used in Montana is limited by State statutes regarding maximum indebtedness and by the fact that voter approval must be obtained before a local government may issue bonds. Additionally, a default on the bond issue may require the issuing government to levy additional taxes on local residents. The process of issuing general obligation bonds may be quite lengthy due to bond election procedures and the complex credit analysis required to market bonds. This time lag may push back project completion dates and result in increased construction costs. Local governments may pay fees to underwriters or financial consultants for assistance in putting financing programs together. This may allow local governments to avoid procedural errors and ultimately speed up the process.
Special Improvement District (SID) Bonds
Special assessment or SID bonds are issued to pay for public improvements where the property benefited by the improvements can be identified. The principal and interest payments are made from a special assessment on the identified properties. These bonds are issued in conjunction with the formation of special improvement districts, and are typically backed by a special improvement district (SID) or rural special improvement district (RSID) revolving fund. (Reference: counties, 7-12-2169, MCA; municipalities 7-12-4201, MCA.)
a. Purpose and usage
Special assessment bonds may be issued to county or municipal governments to defray the costs of capital improvement projects in a rural improvement district (RID) or a special improvement district (SID). Bonds may be issued to pay for all costs incurred through construction or maintenance activities within the special districts. Extensions of sewer or water systems to unserved areas are commonly financed through the issuance of special assessment bonds.
b. Issuing Procedures
The board of county commissioners or the city/town council may sell bonds to pay for the construction or operation and maintenance activities associated with special districts (RID or SID). The Notice of Sale, publication notice, and the procedures for bond sale follow the same provisions as those for general obligation or revenue bond issues, but are subject to different time frames. A public referendum is not required to determine if special assessment bonds should be issued; however, landowners within the special district initially have the opportunity to decide whether or not the improvement should be undertaken, which ultimately determines if the bond will be issued. Debt financed by special assessment bonds is not subject to Montana limitations on bonded indebtedness. The bonds create a lien on only that property benefiting from the improvement. Bond payments are also backed by the creation of revolving funds. (Reference: RID, 7-12-Part 21, MCA; SID, 7-12-Parts 41 and 42, MCA.)
c. Advantages and Disadvantage of Special Assessment Bonds
i) Advantages
The use of special assessment bonds to finance capital improvements is desirable because the burden of cost falls directly on the property owners who are benefited by the improvements. Support of the local government's issuance of the bonds is generally favorable, since a majority of landowners within the improvement district have expressed their approval of the project. Local governments may view the use of special assessment bonds as being quite advantageous for several reasons. First, the debt financed by these bonds is not subject to Montana limitations on bonded indebtedness. Secondly, the bonds may be issued without a bond election, which is usually time consuming and costly to the public. Finally, the issuance of these bonds requires little or no capital from the issuing government. State statutes also allow local governments to invest surplus reserves in U.S. securities or in certificates of deposit which will hasten the retirement of districts debts.
ii) Disadvantages
Two of the primary disadvantages associated with special assessment bonds are directly related to the formation of improvement districts. Since the formation of an improvement district is seldom supported by all of the affected landowners, protesting landowners within the proposed improvement district may delay the project through procedures outlined in Montana law. If the protests result in a lengthy delay, increases in project costs may be significant enough to force cutbacks in or cancellation of the project. In addition, the assessment required of property owners within an RID or SID may unduly impact some individuals, especially in areas with a high percentage of low or fixed-income residents. In the event property owners fail to pay their assessments, the local government may have to levy additional taxes to repay SID or RID revolving funds.
Since special assessment bonds are not backed by the full faith and credit of the issuing government, they represent a greater investment risk than bonds that have such backing. As a result, the bond market generally places a higher interest rate on these bonds than on other types. Administrative, legal and financial consultant costs may comprise a large percentage of the cost on some small improvement district projects. The flexibility of special assessment bonds is limited by Montana statutes regarding authorization, issuing procedures, and general bond provisions. Local governments must be very careful in authorizing SID's or RID's for "raw land" subdivisions. If the lots do not sell, the revolving fund and, ultimately, the local government may have to pay the district's SID bonds (see 7-12-2185 and 7-12-4225, MCA).
Legislation enacted in 1999 allows water and sewer districts to create a hybrid form of revenue bond that combines aspects of a special improvement district bond. Under this new alternative, the water or sewer district can levy special assessments in the same manner that cities can under the SID process. The bonds issued by the district are denoted as revenue bonds but are repaid by special assessments against property within the district that are benefited by the water or sewer improvements. The bonds must still be approved by the voters of the district. The statute (Section 7-13-2221, MCA) sets out the process that must be followed in establishing the assessment methodology and in levying the assessments. As with conventional SID's, the proposed bond issue is subject to protest procedures by affected property owners.
The preceding provides only a very brief overview of the "basics" of local government bonding and is condensed from the Montana Department of Commerce publication, Planning and Financing Water and Sewer Systems in Montana. Copies of the publication can be ordered from MDOC's Community Development Division.
