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                 Jack Vogt, UNC School of Government
                             February, 2005

A.   General obligation (GO) bonds

     1.     Security or collateral for GO bonds is the unlimited legal authority of the
            issuer to levy property taxes. If the issuer stops making payment on this
            type of debt, the unit is in default. The creditors or investors may bring
            suit and force the unit to levy taxes to repay the debt.

     2.     Periodic payment of interest and principal (debt service) on GO bonds
            may come from taxes or other sources, e.g., water-sewer system charges.

     3.     The voters must approve GO bonds

     4.     The Local Government Commission (LGC) must approve all GO bonds.
            GO bonds are generally sold by competitive bid.

     5.     GO bonds are retired over a term of up to 20 years, depending on the
            useful life of the project. A longer term is possible if Federal or state
            loans are involved

     6.     GO bonds have the lowest interest rates of any types of debt Once the
            voters approve GO bonds, they are the simplest and easiest to issue.

     7.     GO bonds continue to be major method of debt financing for N. C. local
            water-sewer infrastructure, e. g., Cary

B.   Installment or lease-purchase (security interest) debt authorized by G.S. 160-
     20 in N. C. The N. C. Supreme Court ruled that local government use of such
     debt is constitutional in Wayne County Citizens v. Wayne County Bd. of
     Commissioners 328 N. C. 24, 399 S. E. 2d 311 (1991).

     1.     Security or collateral for installment or lease-purchase debt is the property
            being financed and/or other property. If the issuer stops making payments
            on such debt, creditors may seize the property and attempt to satisfy the
            debt they are owed by sale or use of the property. The creditors may not
            obtain a judgment requiring the issuer to levy taxes to pay the debt.

     2.     Debt service may be paid from any revenue source, including taxes levied
            by the issuing unit that is not otherwise restricted by law.
                                                                      Capital Finance      122

     3.    The voters do not have to approve lease- or installment-purchase debt,
           because taxing power is not pledged to secure the debt.

     4.    The Local Government Commission must approve lease- or installment
           purchase debt involving the construction or repair of real property, or the
           acquisition of personal property if the debt is outstanding for five years or
           more and requires payments over the life of the debt that exceed 1/10 of
           1% of its tax value or $500,000, whichever is less.

     5.    Lease- or installment purchase debt is issued in two general forms

           a) Simple lease- or installment purchase debt for equipment or for
              buildings that are modest in size.

           b) Certificates of participation (COPs) issued for major projects. The
              financing is divided into shares or certificates that are sold to
              investors. COPs are typically placed initially in a negotiated process
              with an investment banking firm that then re-sells the COPs to the
              public. Break even point is currently about $10 million.

     8.    Simple lease- or installment purchase debt is often the most economical
           method of financing equipment acquisitions. COPs for major projects
           generally carry higher interest rates than GO debt.

     9.    Local governments have commonly used simple lease- or installment
           purchase debt for many years. Cities and counties in North Carolina have
           increased their use of COPs since the Supreme Court decision in 1991.

     10.   Brevard County, Florida and Richmond School District cases

C.   Revenue bonds

     1.    The security or collateral for revenue bonds is the net earnings of a self-
           supporting utility or enterprise, e.g., a water-sewer system. Coverage is
           an important concept in revenue secured debt--investors typically require
           that net earnings cover maximum annual debt service by some coverage
           ratio: 125% for water, 130% or more for riskier enterprises.

     2.    The debt service for revenue bonds is paid from utility or enterprise
           system revenues.

     3.    Voter approval is not required for revenue bonds, because taxing authority
           or power is not pledged as security for the bonds.
                                                                       Capital Finance      123

     4.     The Local Government Commission must approve the issuance of and sell
            revenue bonds The bonds are placed initially in a negotiated process with
            an investment banking syndicate that then re-sells the bonds to the public.

     5.     Revenue bonds can be issued over terms that are longer than 20 years.

     6.     Revenue bonds have higher interest rates, much higher issuance costs,
            and are much more complex debt instruments than GO bonds. Revenue
            bonds usually require reserve funds for debt service and certain other

     7.     In the past, revenue bonds were not widely used by cities and counties in
            North Carolina. However, this is changing, as more and more cities are
            issuing revenue bonds for utility system improvements. Revenue bonds
            have been much more extensively used in other parts of the country.

D.   Special obligation (SO) bonds may be issued to finance solid waste
     management and water-sewer projects.

     1.     The security or collateral for SO bonds is one or more revenue sources
            other than taxes levied by the unit issuing the bonds. For instance, SO
            bonds issued by a city may be secured by sales tax revenue, utility system
            revenue, or state shared revenues.

     2.     Debt service on SO bonds may be paid from any revenue source,
            including taxes levied by the issuing unit, that are not otherwise restricted
            by law.

     3.     Voters do not have to approve SO bonds. Taxing authority or power is not

     4.     The Local Government Commission must approve SO bonds and sells the
            bonds in North Carolina. The bonds are typically placed via a negotiated

     5.     SO bonds have term or maturity structures related to the useful lives of the
            facilities being financed with the bonds. Such terms generally do not
            exceed 20 years.

     6.     Interest rates for SO bonds are higher than for GO bonds. SO bonds tend
            to be complex debt instruments.

     7.     SO bonds are used selectively by local governments for solid waste

     8.     Illustrations: Fayetteville, Arkansas and Junction City Kansas.
                                                                          Capital Finance     124

E. Tax increment bonds. In N. C., also called project development or self-financing
bonds. A city or county establishes a tax increment district and issue bonds to build
public facilities and infrastructure needed to support private development within district.
Growth in property tax valuation occurring after district is formed secures and pays debt
service on the tax increment bonds. Other revenues from within the district may be
pledged to secure and pay debt service on the bonds. Used widely in Midwestern states
and many southern states (S. Carolina). Approved for N. C. by voters in a constitutional
amendment in November, 2004. In N. C., LGC must approve all tax increment bonds.

F. Variable rate demand debt (VRDD) and interest rates swaps

       1. Debt that is issued to finance a capital project that has a long-term, e. g., 20
          years, but for which interest rate resets or is subject to resetting weekly or
          month based on changes in interest rate index in market

       2. VRDD takes advantage of the “normal yield curve” for interest rates.
          Normally, interest rates on long term debt are lower than on long-term debt.
          There is more risk associated with longer term debt.

       3. VRDD must be accompanied by liquidity support and a remarketing agent.

       3. Disadvantage for local issuer of VRDD. Issuer assumes risk associated with
          changes in interest rate. Yield curve can invert; short term rates sometimes
          rise above long-term rates.

       4. Because of risk, LGC recommends that only AA rated local governments use
          VRDD and that such debt not exceed 20 % of issuer’s debt portfolio.

       5. An interest rate swap allows an issuer to swap its obligation to make interest
          payments on its variable rate debt into an obligation to make payments on a
          “synthetic” fixed rate debt. The converse can also be done.

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