One City’s Debt Strategy

Debt Issuance and Cost Savings for the City of Denton

T
he purpose of this article is By Bryan Langley
Assistant City Manager, City of Denton
to share with you the City of
Denton’s strategy regarding the
issuance of debt and how we have
used creative techniques to capture
related savings.

Background
The City of Denton was founded in
1857, and officially incorporated in
1866. For much of the city’s history,
the population and boundaries grew at
steady and predictable rates. Beginning
in the late 1990s, however, the growth
of the city accelerated. In 1990, the
population of the city was 66,270,
and it grew by 25% to a population of
82,976 by 2000. Currently, the city’s
population is estimated to be approxi-
mately 121,000, which represents a
46% growth rate since 2000. Since
2006, the U.S. Census Bureau has
ranked Denton in the top 25 of the
fastest growing cities, with populations
of 100,000 or more. According to the
latest U.S. Census Bureau 2012 popula-
tion estimates, the City of Denton was
ranked 13th among the fastest growing
cities in the nation, with populations of
100,000 or greater.
Denton is the home of two major
universities; University of North Texas
and Texas Woman’s University, which
have a combined enrollment of approxi-
mately 50,000 students. It has also
developed into a regional center for
medical services, and is home to two
major hospitals. The city is strategi- of Denton’s population will approach operations, including police, fire,
cally located 35 miles northeast of Fort 207,000 by the year 2030. Denton libraries, planning, and parks and recre-
Worth,37 miles northwest of Dallas, will need to issue additional debt in the ation. The cost drivers for these activi-
and only 18 miles north of Dallas/Fort future to build the needed infrastructure ties are typically the personnel costs
Worth (DFW) airport. As a result, to support this growth. associated with the services provided. In
Denton is well positioned to grow the General Fund, for example, approxi-
rapidly in the coming years. In fact, Denton Service Profile mately 73% of the costs are related to
the Center for Economic Development The City of Denton provides a number salaries and associated benefits.
and Research with the University of of general government services which In addition to the general govern-
North Texas estimated that the City are usually found in municipal ment activities described above, the

28 T E X A S T O W N & C I T Y Q  MARCH 2014


city also operates several other self-
supporting (or enterprise) activities.
Self-supporting activities, by defini-
tion, generate enough resources from
rates and/or fees to pay for the cost of
their operations. Denton provides the
following:
• Electric utility operations
including distribution and trans-
mission services.
• Water utility services including
the operation of a water treatment
plant.
• Wastewater utility services
including the operation of a
wastewater treatment plant.
• Solid Waste services including the
operation of a municipal landfill.
• Airport services.
MARCH 2014
These services are capital intensive
operations, and the cost drivers for
these activities are dramatically different
than the General Fund components
discussed earlier. In the Electric Fund,
for example, only 7% of the costs in this
fund are related to personnel costs. The
majority of expenses here are tied to the
capital program and purchased power
contracts. Likewise, capital program
costs and the related debt service is a
significant portion of the other enter-
prise operation budgets in the City of
Denton.
The city expects to issue approxi-
mately $460 million in debt over the
next five years to fund the capital
program for our enterprise opera-
tions. In addition, Denton also plans
to issue debt for other planned general
government capital programs. The city’s
strategy on how to issue this debt is a
critical part of our financial plan.
Municipal Bond Insurance
The City of Denton’s General
Obligation bond rating is AA from
Standard & Poor’s, and AA+ from
Fitch Ratings. The City of Denton’s
Utility System (Electric, Water, and
Wastewater operations) has a bond
rating of AA- from Standard and Poor’s,
and A1 from Moody’s. In years past,
the city benefitted from municipal
bond insurance to obtain the lowest
interest cost available. The economics
of this practice depend on the cost of
the bond insurance premium being less
expensive than the projected interest
cost savings associated with a higher
credit rating. After the financial crisis
in 2008, municipal bond insurance was
virtually non-existent. As a result, the
city evaluated other approaches to find
a lower cost strategy.
Without bond insurance, the city
would be required to issue Utility
Q  T E X A S T O W N & C I T Y 29
System Revenue Bonds at their under-
lying credit rating of AA-/A1. Revenue
bonds are only payable from the direct
revenues generated by each utility, and
their credit rating is generally lower than
General Obligation (GO) bonds which
carry a tax pledge. As a result, if the
city were to issue revenue bonds for its
utility operations (without municipal
bond insurance), the interest rate would
be approximately 0.3% higher than the
rate available on our GO bonds which
have a higher credit rating. While this
percentage difference may not seem
large, it equates to approximately a $2
million savings over a 20 year term for
a $50 million bond issuance.
Debt Strategy and Interest Cost
Savings
To address these issues, the City of
Denton began issuing Certificates
of Obligation (COs) to fund utility
system projects in 2010. The city has
also refunded existing Utility System
Revenue Bonds with GO Bonds when
economical. This strategy counteracts
the absence of municipal bond insur-
ance, and the widening of credit spreads
in the financial markets. By doing so,
the interest costs associated with debt
Type of Debt
Revenue Supported GOs
Tax Supported GOs
Total General Obligation Bonds (GOs)
Revenue Supported COs
Tax Supported COs
Total Certificates of Obligation (COs)
Utility System Revenue Bonds
Total Revenue Supported Debt
Total Tax Supported Debt
Total Debt Outstanding
30 T E X A S T O W N & C I T Y Q  MARCH 2014
issues have been significantly reduced.
Unlike revenue bonds, COs do not
require that a reserve fund be established
(typically one year of debt service), so
there is considerable savings.
The strategy also shifts the respon-
sibility of who is ultimately responsible
for paying the debt. With utility system
revenue bonds, the utility ratepayers
accept the sole obligation of paying the
associated debt service. In contrast,
COs contemplate that the bonds will
be repaid through some revenue source
(utility revenues in Denton’s case) and
are backed by a tax pledge. The taxpayer
is now acting as a guarantor of the utility
system debt, much like bond insurance.
In discussions with our City
Council, our policy makers could not
foresee a time when they would ever
allow a municipal utility to “default” on
their revenue bond debt. As a result, it
was determined that it would be appro-
priate to explicitly state this and back
any debt issue with a tax pledge.
The City of Denton has elected to
dedicate any interest cost savings asso-
ciated with the sale of COs for utility
operations (as compared to utility system
revenue bonds) to street maintenance
activities. Since the utility operations
Exhibit A
Remaining Remaining
Prinipal Interest
$56,284,412 $12,822,414
80,405,588 22,625,720
$136,690,000 $35,448,134
$220,500,000 $81,098,462
39,970,000 11,024,071
$260,470,000 $92,122,533
$144,225,000 $42,721,157
$421,009,412 $136,642,033
120,375,588 33,649,791
$541,385,000 $170,291,824
would either have been required to pay
municipal bond insurance premiums,
or pay higher debt service associated
with their underlying credit rating,
these transfers have no impact on the
ratepayers, and provide a direct benefit
to the taxpayer who is guaranteeing the
debt payment.
In FY 2013-14, the interest cost
savings associated with this program are
generating approximately $380,000 in
revenue to the City’s Street Improvement
Fund. This approach is expected to
generate approximately $900,000 annu-
ally by FY 2016-17. By issuing COs
in lieu of revenue bonds, the City of
Denton expects to save approximately
$18 million over a 20 year period. If
the city had continued to issue revenue
bonds with or without bond insur-
ance, these dollars would have left our
community in the form of higher bond
interest payments.
Exhibit A provides a summary
of the City of Denton’s outstanding
debt as of September 30, 2013. Debt
which has been sold in connec-
tion with this program is denoted as
“Revenue Supported GOs” or “Revenue
Supported COs”. The amounts in these
categories represent obligations of the
(continued on page 42)
Total
$69,106,826
103,031,308
$172,138,134
$301,598,462
50,994,071
$352,592,533
$186,946,157
$557,651,445
154,025,379
$711,676,824
One City’s Debt Strategy - Debt Issuance and Cost Savings for the City of Denton
(continued from page 30)
utility system which are expected to be
paid through utility revenues and are
backed by a tax pledge.
Keeping Our Citizens Informed
The City of Denton supports transpar-
ency initiatives at all levels of govern-
ment. We participate in the Texas
Comptroller’s Leadership Circle Award
program at the “Gold” level, which is
the highest recognition level available by
the Comptroller’s Office. In addition to
the Comptroller’s program guidelines,
we also provide an annual summary of
the City’s overall debt, links to every
bond issuance "official statement", and
other relevant financial information
on our website. To further promote
transparency and provide our citizens
with needed information, all of our
budget matters and debt issuances are
discussed in a public forum, and the
meetings are broadcast on our local tele-
vision station and streamed live on our
website. In short, the City of Denton
has been transparent through our open
42 T E X A S T O W N & C I T Y
meetings, citizen engagement, and by
providing comprehensive information
to the public.
According to state law, revenue
bonds may be approved solely by a City
Council without an election. While
the deliberation and consideration of
revenue bonds may be very similar to
that of COs, the approval process for
COs is significantly different. Most
notably, COs require a municipality
to publish what is known as a Notice
of Intention to issue debt. Under this
process, citizens of the community are
notified of the proposed CO issuance,
and the date when the authorization of
the COs will be considered by the City
Council. In addition, under state law, if
citizens do not agree with the issuance of
COs, they have the ability to sign a peti-
tion which could require the Council
to call an election on whether the COs
should be issued. In this way, COs
represent a more transparent method of
issuing debt than revenue bonds since
it requires more citizen notification in
the issuance process.
Q  MARCH 2014
Conclusion
Compared to revenue bonds, COs can
be a more economical and responsible
way for cities to lower their borrowing
costs to benefit of ratepayers and
taxpayers alike. The interest cost savings
of this approach is compelling, and
there is the added benefit of not being
required to create and maintain a costly
debt service reserve fund. On the other
hand, city officials should be aware that
COs require a Notice of Intention to be
published prior to their issuance. This
notice could subject the bond sale to a
potential petition to call an election on
the sale of debt. As a result, COs may
not always be the appropriate financing
mechanism in all situations.
In conclusion, COs are a very impor-
tant tool for cities. COs provide local
jurisdictions and officials with needed
flexibility when they seek to acquire
financing. Without this flexibility, our
citizens in the City of Denton would be
forced to absorb much higher interest
costs than what is otherwise available. +