Evolving Debt Finance Practices for Surface Transportation (2017)

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9 chapter two Use of Debt finance for sUrface transportation introDUction Drawing on the literature review and survey, this chapter reviews the use of debt among states for surface transportation, including general statistics and information regarding debt issuing authority and manage- ment practices. For full state responses to the survey’s qualitative responses, please see Appendix C. The chapter discussion highlights select responses. The topic areas addressed in the chapter include: • Authorized purposes of debt, debt types, and structures; • Constitutional and statutory provisions governing debt issuance procedures; • Policies for debt issuance and management; • Outstanding debt levels; and • Debt capacity planning. aUthority to issUe Debt Who has authority to issue Debt? Many state entities have authority to issue debt for specific purposes. In some states, the state DOT or state transportation board or commission has authority to issue debt for surface transportation pur- poses. In other states, a state-sponsored toll, turnpike, or bridge authority has debt issuance authority, either in addition to or in lieu of the state transportation agency. In other states, debt issuance author- ity rests solely with the state treasurer, bond commission, or other designated administrative agency of state government. In many cases, state DOTs are required to go to a bond review board or other external state entity for final authorization. Of the 44 responding state DOTs, 95% (42 states) have authority to issue debt for transportation investment (see Figure 7). The two state DOTs reporting they do not have the authority to issue debt for transportation investment are those of South Dakota and Vermont, whereas the Nebraska agency reports limited authority to issue transportation-related debt. As reported by the state DOTs, the entities with authority to issue debt primarily include state DOTs (40%); independent state toll, turnpike, or bridge/tunnel authorities (36%); and state treasurers (31%). Seventeen (40%) of the responding state DOTs, report other entities with authority to issue transportation debt (see Figure 8). Such entities include state bond committees or commissions and departments or offices of management and budget. Examples include Florida’s Board of Administra- tion’s Division of Bond Finance, the Idaho Housing and Finance Association, the Maine Municipal Bond Bank, and the Tennessee State Funding Board. Where is authority Derived? Authority to issue debt is derived primarily from states’ constitutions or statutes (see Figure 9). Other sources of issuing authority include special citizen referendums and legislative amendments. The Colo- rado state constitution does not allow issuance of debt without a vote. However, the Colorado legis- lature allows the establishment of “enterprises” that can secure debt. North Carolina has automatic authority and does not need legislative approval as long as projects remain under the debt limit. The

10 Iowa State Code gives the state treasurer authority to issue a variety of debt types and determine the most economical method of financing for requests by state agencies. for Which purposes is Debt issued? Debt is issued for many transportation-related purposes. As shown in Figure 10, 95% (40 states) of state DOTs responding to this portion of the survey have the authority to issue debt for non-tolled highways and bridges, and 64% (27 states) of those responding have the authority to issue debt for tolled highways, bridges, and tunnels. Additional authority exists for debt that supports investments in rail, ports, transit, airports, and ferry and marine transportation facilities. Respondents identified the following as other transportation investment needs for which their agencies issue debt: • Local roadways, • Administrative facilities, • Right-of-way acquisition, and • State infrastructure bank capitalization. FIGURE 7 Map of states’ authority to issue transportation debt. Note: States that appear blank on the map did not respond to this survey question. FIGURE 8 Entities with the authority to issue transportation debt (n = 42). FIGURE 9 Source of authority for transportation debt issuance (n = 42).

11 Which types of Debt are authorized? As shown in Figure 11, 76% (32 states) of responding states have authority to issue bonds backed by dedicated highway/transportation revenues. Other common types of debt authority for surface trans- portation include toll revenue bonds, general obligation bonds, grant anticipation bonds or notes, and borrowing from the federal government, such as through the TIFIA and RRIF programs. Examples of authorities sanctioned to issue some other kind of long-term debt (generally greater than 1 year in duration) include Arizona’s Board Funding Obligations, which allow borrowing excess cash flow from the State Treasurer, and Florida’s Fixed Guideway Bonds and Transportation Financing Cor- porate Loans. Which Debt structures are authorized? States with the authority to issue debt do so in a variety of forms or structures. As shown in Figure 12, 95% (40 states) of state DOTs responding to this portion of the survey report the ability to issue long- term debt, and a significantly smaller portion (38% or 16 states) have the authority to issue short-term debt. The ability to issue fixed-rate debt is reported by 71% (30 states) of respondents, and 62% (26 states) report the ability to issue variable rate debt. The limitation on short-term borrowing repre- sents a constraint on the ability to use debt for cash management purposes. Iowa and Tennessee report they have no authorized debt structures (reported as “other” in Figure 12). FIGURE 10 Purposes for which debt may be issued (n = 42). FIGURE 11 Types of debt currently authorized (n = 42). Long-Term Debt Fixed Rate Debt Variable Rate Debt Short-Term Debt Bond Anticipation Notes Use of Derivative Products Commercial Paper Interagency Borrowing Other FIGURE 12 Debt structures currently authorized (n = 42).

12 Do constitutional or statutory provisions Govern Debt issuance procedures? As shown in Figure 13, of 43 state DOTs responding, 37 report constitutional provisions or statutes that govern the manner in which debt can be issued. States that report no constitutional or statutory provisions for how debt is issued include Iowa, Missouri, Nevada, Oklahoma, and South Dakota. Iowa has no formal or informal procedures outlined for debt issuance. Iowa and Tennessee are pay- as-you-go states. As shown in Figure 14, 32 states (89%) report constitutional and/or statutory limitations on the dollar amount of debt issued or outstanding, 23 of which were statutory limits and nine of which were constitutional. Thirty-one states report limitations on debt service terms such as the number of years outstanding, with 22 of those being statutory limitations. Vermont has statutory limitations regarding the amount of debt issued by the state treasurer and requires that the Vermont legislature approve debt issuance. formal and informal policies for issuing Debt Rules governing debt issuance and management include bond covenants, policies, and practices. Bond covenants are outlined in the legal documents that govern the issuance and are legally binding terms of agreement between a bond issuer and a bondholder. Policies are put in place by the issuing entity to manage their debt and can be informal or formal and potentially adopted by a governing body. Prac- tices are the standard procedures that debt managers follow but are not the official policy of the entity. The survey for this synthesis asked state DOTs if they have a formal or informal policy for debt issuance-related items listed in Figure 15. The survey instructed respondents to select all that applied and leave blank any items for which they have no formal or informal policy, and add categories in the last field as applicable. In this context, debt structures refer to the duration and timing of principal and interest payments. The structure typically refers to characteristics such as the maturity dates, the repayment of principal terms, and the provisions for prepaying the loan. Of the 37 states responding to this section of the survey, the most common policy describes the purposes for which debt can be Yes, 37 No, 6 FIGURE 13 States with constitutional or statu- tory provisions for debt guidance (n = 43). Constitutional Limits on amount issued or outstanding by the state 9 Limits on outstanding debt relative to a specific benchmark 5 9 Limitations on debt structure types 5 17 Limits on debt service terms (i.e., years outstanding) 9 21 Limits on allowable sources for debt service repayment 6 18 Limits on the use of bond insurance or other credit enhancement 0 5 Limits on the debt issuance method (i.e., competitive versus negotiated) 0 7 Prohibition on dedication of revenues 1 0 Statutory 23 FIGURE 14 Number of states with limitations on transportation debt that are either constitutional or statutory (n = 36). Written Informal Amount of total transportation-related debt that can be issued or outstanding 12 5 Amount of debt relative to a fixed benchmark that can be issued or outstanding 15 7 Purposes for which debt can be issued 24 5 Debt structures 11 5 Debt terms (i.e., years outstanding) 15 4 Use of fixed vs. variable rate debt 12 6 Use of negotiated sale vs. competitive bid sales 8 8 Use of bond issuance or other credit enhancements 8 6 Use of derivative products (e.g., interest rate swaps) 12 5 Minimum credit ratings 7 3 FIGURE 15 Number of states with written or informal policies related to transportation debt (n = 37).

13 issued. Twenty-nine (78%) of respondents to this question report their state has policies regarding the purposes for which debt can be issued, of which 24 states’ policies are formal (e.g., adopted by a governing body) and five informal. The second most commonly reported policy relates to the amount of debt that can be issued or outstanding relative to a fixed benchmark. Fifteen respondents report a formal policy in this area and seven an informal policy. overview of Debt Management policies Respondents from 14 state DOTs provided complete copies of their debt management policies as part of the survey. In some states, such policies are specific to DOT or transportation-related debt. Other states establish policies that govern all debt issuance in the state. Establishing debt capacity limits is a key policy area for most states, and their policies typically include detailed approaches for calculating debt affordability. Examples are provided here (see Additional Resources, References, and Links for State Debt Management Policies and Appendix C for more detailed state responses). • Alaska—Debt service on general obligation bonds and state-supported debt (obligations that are based solely on the state’s commitment to annually seek appropriation for repayment) in any year shall be targeted not to exceed 5% of the projected year’s unrestricted revenues with an absolute not-to-exceed ceiling of 8%. • Georgia—The ratio of debt service to prior year revenues shall not exceed 7% without GARVEEs and 8% with GARVEEs. Debt to personal income shall not exceed 3.5% without GARVEEs and 4% with GARVEEs. Debt per capita shall not exceed $1,200 without GARVEEs and $1,500 with GARVEEs. • Louisiana—Debt service cannot exceed 6% of the estimate of money to be received by the state general fund and dedicated funds in any fiscal year. • Michigan—The ratio of restricted revenue (as calculated by industry standards and the state’s financial reports) to the average annual debt service shall not be less than four times. • Missouri—A fixed percentage not to exceed 20% of the annual total road and bridge revenue may be used to meet the repayment requirements of debt obligations. Maintain at least 5.0 times the debt service coverage from pledged state revenue on first lien debt, at least 4.0 times the debt service coverage from pledged state revenue on second lien debt, and at least 3.0 times the debt service coverage from pledged state revenue on third lien debt. • Nevada—The aggregate principal amount of the state’s outstanding general obligation debt is to be 2% of the total reported assessed valuation of the state at the time of issuance of bonds minus one-half of the current fiscal year’s debt service for nonself-supported general obligation debt. As these examples show, and consistent with findings in the literature, debt affordability metrics and guidelines are based on total state indebtedness and are not specific to transportation debt levels. New guidelines are introduced over time. One example is Georgia’s explicit policy for the treat- ment of GARVEE debt in measuring overall indebtedness, which was referenced previously. This is an example of how states adapt their policies with new mechanisms or expand the use of existing mechanisms, within transportation and more generally. The rating agencies also continue to develop their guidelines in response to new debt mechanisms and expanded use of niche tools. The section Additional Resources, References, and Links for State Debt Management Policies provides references for rating agency reports related to transportation debt topics, such as GARVEE debt and availability payments. Additional issuer-specific reports are also valuable resources. cUrrent anD planneD Debt capacity current Debt issued and outstanding As Figure 16 shows, 36 of 42 (86%) responding states report state-issued debt outstanding to sup- port highway, bridge, and tunnel projects. Nebraska, Vermont, South Dakota, Iowa, Wyoming, and Tennessee report no outstanding debt. Nineteen (48%) respondents report state-issued outstanding

14 debt for other transportation modes, including transit, airport, rail infrastructure, and rolling stock. Sixteen states report no debt for these modes, and six responding states are unsure. States were asked what percentage of transportation revenues within the purview of the state DOT were utilized for debt service payments in 2015 (note: all refundings and other one-time restructuring payments were to be excluded). The most frequently reported amount is 5% to 10% (see Figure 17). Sixty-three percent of respondents report 10% or less of transportation revenues were used for debt service payments. Nine states report less than 1%, and seven states report 16% to 24%. New Jersey, Utah, and Washington report 25% or more. These results are consistent with the data presented in chapter one, which show a 10-year trend line of debt service across all states reporting to FHWA. According to FHWA, as of 2014, states collectively used 12% of disbursements for interest and debt retirement payments. Debt capacity planning Most (23 of 37) responding states report that they forecast current and future debt capacity and debt levels as part of a capital planning process or financial plan (see Figure 18). The length of time cov- ered by such forecasts varies from 2 to 30 years or the term of the debt. FIGURE 17 Percent of 2015 transportation revenues used for debt service payments (n = 40). FIGURE 16 Map of states with outstanding debt for roadway investment and other transportation purposes. Note: States that appear blank on the map did not respond to the survey question.

15 For example, Wisconsin forecasts debt capacity as part of the state’s biennial budget process, which estimates debt service payments for the upcoming 2 years. Similarly, Kentucky performs debt capacity analysis for the state’s appropriation-supported debt, and typically forecasts cover at least 2 years but sometimes forecast 4 or 6 years, depending on the need. Maryland produces a forecast as part of the state’s 6-year financial plan. Maryland’s plan forecasts the annual bond proceeds that would be required to cover the plan’s capital cash flow projections. The plan assumes debt issuances occur until the statutory cap on bonds outstanding or the minimum debt service coverage ratio is reached. Ohio forecasts annual transportation program appropriation levels needed for capital bond pro- grams. Based on project payout estimates, the timing and amount of bond issuance is estimated. Ohio also forecasts the next 15 years of debt service and outstanding principal on existing and planned issuances to monitor compliance with constitutional and statutory limitations as well as bond covenants. Nevada takes a longer view and projects cash flow and coverage ratios for 20 years. In Texas, only one debt program is authorized as a perpetual fund; all other debt programs are authorized with predetermined caps. Debt capacity for the perpetual debt program is based on the state comptroller’s 30-year forecast of revenues used to pay debt service. Yes, 23 No, 14 FIGURE 18 States that forecast current and future debt capacity levels (n = 37).