Why Direct Lending Is The Optimal Financing Solution for Municipalities

by: Lance S. Holman

Avoid Raising Taxes with Direct Lending

Financing capital projects, such as equipment, infrastructure, facility, energy needs and unfunded pension obligations, can be complex and time consuming. Allow me to contrast the differences between direct lending and traditional bond financing.

Direct Lending

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MUNICIPAL BONDS

PROJECT FUNDING AND CASH FLOW

Direct Lending provides fixed and floating rate debt instruments to fund your projects. Additionally, your municipality can neutralize short-term cash flow gaps with a revolving line of credit. The municipality maintains title to the asset. Financing terms range from 1 – 30 years. The assets financed or a revenue stream serve as the collateral or security for the loan.

Bond Financing funds projects through fixed rate and floating rate structures. Short-term cash flow declines are funded with revenue anticipation notes. Financing terms range from 1-50 years. The assets financed, a revenue stream, or a voter approved tax pledge serve as the security for the bond.

NO VOTER APPROVAL REQUIRED VS. RAISING TAXES

Direct Lending governmental activity loans are structured as capital leases, and the payments are subject to the municipality annually appropriating the payments to the lessor at a scheduled governing body meeting. This contingency allows the municipality to avoid voter approval because it uses existing revenue and not a tax rate increase to repay the capital lease. The general fund is the primary source of repayment. Loans supported by enterprise funds are repaid by the municipality’s user fees from the specific water, sewer, or airport revenues and also do not require voter approval.

Bond Financing in many states, for governmental activities, requires voter approval to raise taxes to pay the debt service on the bonds. Enterprise fund debt is repaid from the user fees of its water, sewer, and airport funds respectively and do not require voter approval.

BORROWERS AND INVESTORS

Direct Lending involves the borrower and lender entering into a private placement loan agreement to fund new projects and/or refinance existing debt. The lender is typically a bank, but can be an insurance company, investment fund, or high net worth investor.

Bond Financing requires the municipality to hire a team of finance professionals, including a rating agency to review the municipality’s creditworthiness, a trustee to collect bond payments and pay bondholders, bond counsel to draft the debt agreements, an underwriter to buy the bonds, and a financial advisor to coordinate the process on behalf of the municipality. The investor is typically an investment fund, insurance company, bank, or high net worth investor.

WHAT WE FINANCE

INFRASTRUCTURE

Roads & Bridges
Pipelines
Street Light Systems
Water Treatment Plants
Renewable Energy Plants

Energy

Energy Performance Contracting
Renewable Energy
Central Plants

EQUIPMENT

911 Emergency Response Systems
Patrol Calls
Fire Trucks
Maritime Vessels
Public Safety Aircraft
Energy Management System

FACILITIES

Administrative Facilities
Fire Stations
Police Stations
Court Houses
Transportation Garages

Direct Lending

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MUNICIPAL BONDS

SIMPLICITY OF ISSUANCE and DOCUMENTATION

Direct Lending contemplates the use of standardized documentation, which enables the funding of multiple loans under a comprehensive Master Financing Agreement (MFA).  The MFA provides for the borrower and lender to create individual loans, each having its own interest rate, financing term, customized payment schedule, and maturity date. The MFA allows the municipality to create loans from $250,000 to $200,000,000. The interest rate is held firmly for 30-45 days while the municipality completes its governing body approval process. Once set, the interest rate and payments remain fixed for the term of each loan extended under the MFA.

Bond Financing involves creating individual debt obligations, each memorialized with its own set of bond documents. State and federal regulations create a heavy compliance obligation as the bonds are sold to the public. The municipality raises the capital by selling the bonds to an underwriter at a discount or premium, which in turn resells them to an investor. The bonds are sold as serial bonds with a portion of the bond maturing at regular intervals and each one maintaining its own interest rate. Bond financing can be a small as few hundred thousand dollars and up to billions of dollars.

How Master Financing Agreements Work

Direct Lending

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MUNICIPAL BONDS

INTEREST RATES and EARLY PAYOFF FLEXIBILITY

Direct Lending interest rates are set based upon the financing term, borrowers’ creditworthiness, ability to pay off the loan early, and market interest rates for all debt instruments. The loan has one interest rate for the entire financing, which is similar to a mortgage loan. Once set, the interest rate is fixed.  The municipality is permitted to pay off the loan balance in full on any scheduled payment date with 30 days’ prior written notice.

Bond Financing interest rates are set on the day the bond is sold to the public and fixed for its entire term. The bond’s total interest cost is calculated by analyzing each serial bond and term loan individual interest rates, the cost of issuance, and time value of money. The municipality is typically prohibited from paying off the bond early for an extended period of time. For example, the terms of a 30-year bond typically do not permit the municipality to pay off the bond for the first 10 years.

TIME and FEES

Direct Lending accelerates the funding process to 30 days or less and allows the municipality’s executive team and its legal counsel to work directly with the lender and its legal counsel. This process is more efficient and can be more cost effective than assembling a suitable team to manage a bond offering.

Bond Financing involves many more parties and various finance professionals, as stated above.  It may take months to assemble a team, place the item on the ballot, and sell the bonds to an underwriter.

As your trusted capital planning partner, please contact me to help you customize a direct lending financing solution to serve your needs now and in the future.

Lance Holman Headshot

Lance S. Holman

President & CEO

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