Friday, May 7, 2010

MN Debt Service Problem

Minnesota’s Debt Service Situation
Many states, including Minnesota, have used general obligation bonding to relieve pay-as-you go budget constraints. However, as Minnesota continues to issue bonds in increasing dollar amounts, the total costs associated with paying back the debt increases from year to year.

For the FY2010-2011, the share of Minnesota’s debt service to its total expenditures is forecasted to be at 2.8%, or about $956 million dollars of a $31 billion dollar budget.

Of that total, approximately 82% of the bonds issued were general obligation bonds, with the remaining 18% transportation and revenue bonds. Compared with the forecasted general revenue for the same fiscal year, Minnesota’s general obligation debt service ratio will reach 2.99%, a substantial increase from previous years, when it has remained below 2%. The Minnesota Department for Management and Budget has predicted that at current levels of borrowing through issuing general obligation bonds, Minnesota’s debt service costs will grow at a median rate of 4.2% annually for the next five years. At that rate of increase, it is predicted that Minnesota will need to increase its suggested debt service ratio limitation to 3.2% of the state’s income.

Continued increases in general obligation bonds issued by the State of Minnesota, combined with decreases in revenue from the current economic recession will cause the debt service ratio to grow as a percentage of general revenue. The growth in the debt service ratio has the potential to induce negative consequences on the State’s financial situation, such as increasing the costs for future borrowing. Additionally, increasing debt service costs will add further constraints on the State’s ability to fund other expenditures during a time with budget limitations. In order to mitigate the potential costs associated with an increased general obligation bond debt service, the State should consider two options: 1) increase revenues through either expanded economic growth in the state or revenue generating taxes to increase the total general revenue budget, or 2) decrease the amount of general obligation bonds issued for a period of 5 years to allow the total debt owed by the state to decrease.

Through increasing the state revenue, the share that the debt service represents of the total will decrease, improving the debt service ratio for the state by increasing the denominator used when calculating the ratio. Increased revenue generation would also have the added benefit of reducing the perceived risk assessed by bond rating agencies, and improve the credit history of the state, thus reducing the borrowing costs in the future. Increasing Issuing fewer bonds for a five year period would have a similar effect, reducing the rate of growth the state is engaging in bond issued debt. Furthermore, at five years, 40.7% of Minnesota’s existing bond debt will be paid off, dramatically reducing the amount of total debt the State needs to pay through annual debt servicing on its general obligation bonds, improving the credit rating of the state, and freeing up revenue to invest in other departments of the budget.


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