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Bonds and bond financing

Bond financing is typically used to finance capital projects. When a municipality wants to build a new facility it issues bonds to finance that facility. Bonds are secured either by property taxes or user fees. Bond terms are inversely related to interest rates, i.e. when interest rates are high, municipalities will try to avoid long-term debt financing and issue short-term bonds. Bond financing is useful for large municipalities that have good bond ratings. Small municipalities may have more difficulty raising capital through bond issuance because they are usually not rated.

Types

Community bonds, tax-exempt bonds, general obligation bonds

Applications

A wide range of infrastructure including water and sewer system upgrades, road resurfacing and new recreational facilities.

Community Bonds

Municipalities can raise a portion of their infrastructure debt financing from within the local community through community bonds. Issuing community bonds is essentially the same as securing a regular debenture bond, but it does involve more work on the part of local municipal officials.

Benefits

  • Local governments control setting the interest rate, which can be lower than the prevailing bond rate.
  • Citizens may value the opportunity to invest in their own communities and the opportunity to forego higher interest earnings in favour of making a contribution. This in turn can create a stronger sense of community ownership.
  • Municipalities benefit from lower borrowing costs, which can lead to lower project costs and lower overall taxes.
  • Interest paid on the bonds usually stays within the community.
  • Community bonds expand the range of investment for everyday citizens.

Barriers and challenges

  • Developing a community bond program takes significant effort from municipal government officials.
  • The available amount of financing is limited to the savings pool within the community.
  • Projects financed through community bonds must have broad public appeal for the bonds to sell.
  • Bonds can result in high long-term costs to the public.

Resources and notes

  • Provincial involvement is required. Community bonds are issued in the 5‒25 year range, with an average of five years, so they are better as a short to medium-term financing option.
  • Several years ago, the Municipal Finance Authority of British Columbia developed a province-wide community bond program. Every BC municipality can issue community bonds, which are backed by the MFA's AAA credit rating. MFA has created templates and manuals for the program.
  • New Tools for New Times

Municipal examples

  • New Denver, BC raised $220,000 in 2005 to pave local roads.
  • Montrose, BC raised $200,000 in 2004 for electrical system upgrades and power line installation.


Tax-exempt bonds (TEBs)

TEBs are used extensively throughout the U.S. to finance local infrastructure. The interest earnings to the bondholder are exempt from federal and state income tax, which allows the government issuing the bond to sell it at a lower interest rate than the prevailing market.

Benefits

  • Greater access to financing at lower interest rates, which decreases overall costs.
  • Politically, TEBs are well received and the take-up rate is good.
  • They can have a strong correlation to specific projects as well as general economic investment.
  • TEBs are attractive to investors due to the tax advantage and high degree of security.

Barriers and challenges

  • Viewed by some as a regressive application of a federal tax subsidy that favours those who have the money to invest in the first place.
  • Pension funds, RRSP investors and governments hold about 65% of municipal debt in Canada and would not likely invest in TEBs because they cannot realize the tax benefits.
  • Markets in Canada may not be big enough to support TEBs.
  • To issue TEBs in Canada, provincial and federal governments would need to amend existing tax legislation.

Resources and notes



General Obligation (GO) Bonds

Canadian municipalities may issue GO bonds, also called serial or sinking fund debentures. Bonds are issued for a fixed number of years, with a certain number reaching maturity and being redeemed by the municipality or provincial agency each year.

Applications

Virtually any large infrastructure type, but particularly ones with a long life span, e.g. buildings, water infrastructure.

Benefits

  • GO bonds are best for infrastructure with a long life span that provides community benefits, e.g. water and wastewater plants, municipal buildings such as fire and police stations.
  • Most self-financing GO bonds are not part of the provincial debt ceiling.

Resources and notes



Page Updated: 18/09/2015