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Use of Bond Proceeds by a City or Village

November 4, 2014 by Robert J. Schillerstrom, Partner
Ice Miller attorneys offer helpful information on the financing alternatives available to Illinois Cities and Villages pursuant to Illinois law and consideration to federal tax and securities laws. Learn how we can help through our guide, “Financing Options: Using Bonds for Illinois Cities and Villages.” An excerpt follows:
Municipal bonds, or “munis” as they are commonly called, can be issued for a variety of purposes, provided that their issuance accords with Illinois law. Commonly, cities or villages issue municipal bonds for capital projects, working capital needs or refinancing of prior debt.
A. New Projects. Generally, a municipality compiles an annual capital improvement budget or prepares a “needs list” or a Capital Improvement Program, or “CIP,” that spans a number of years (commonly six years), which consists of projects the municipality considers to be important by means of its impact on the safety, economy and general well-being of the local community. Capital projects can be funded by federal or state grants, local improvement district assessments, service area levies and other miscellaneous revenue available for general purpose use. However, the primary sources of local funding to pay for capital projects are municipal bonds. Projects involving roads, bridges, water facilities, sewer facilities, electrical facilities, municipal buildings or economic development initiatives are examples of projects that are commonly financed with bonds. Thus, generally speaking, if a municipality is building a new capital project, it is likely that the proceeds of a municipal bond issuance are financing the project.
Often times capital projects are of long term value to citizens (such as buildings, roads, land development, parks, etc.). Issuing bonds to fund a capital project allows current and future taxpayers within the community to pay related costs over the life of the project as they avail themselves of the benefits it bestows upon the community.
B. Covering short-term (or long-term) needs. Cities or villages can issue bonds to fund working capital expenditures that arise from a variety of circumstances. Traditionally, working capital bonds have been issued as short-term obligations where the proceeds are used to cover an issuer’s temporary cash flow, or operating, deficit. Short-term budgetary deficits can arise from a mismatch between the receipt of annual revenues (property taxes or other) and the timing of annual expenditures of the issuer within a year. Tax anticipation warrants (“TAWs”) are often issued in anticipation of taxes levied but not yet collected. TAWs may be issued in an amount up to 85% of the total amount levied for the particular fund against which the TAWs are issued. Longer-term working capital bonds have become more commonplace in recent times due to financial difficulties stemming from the recent economic crisis. Municipalities use these longer-term working capital bonds to address structural deficits that are not the result of a mismatch of revenues and expenses. Insurance reserve bonds, tort judgment funding bonds and working cash fund bonds are permitted under Illinois law assuming certain requirements are satisfied. Certain federal income tax issues exist in connection with working capital financings.
C. Refundings/Refinancings. Like a homeowner who refinances their mortgage when interest rates drop, a municipality with outstanding debt can issue refunding bonds in order to take advantage of lower rates. Refunding bonds can also be issued to avoid default or restrictive debt burden. A refinancing can be done as a current refunding, which means the old bonds are called or mature within 90 days of the issuance of the refunding bonds, or an advance refunding (limited to one occurrence) where the old bonds are called on a specified call date and proceeds of the new refunding bonds are typically held in an escrow account until such later call date at least 90 days after the issuance of the refunding bonds. Refundings generally do not need to satisfy direct or backdoor referendum requirements.

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