Non Ad Valorem Bonds......................................................................................................
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on ad valorem debt has become a popular
alternative to GO bonds for many reasons.
In addition to bypassing referendum require-
ments, many issuers believe that non ad valorem
bonds spread the burden of repayment more equi-
tably among residents and non-residents, includ-
ing tourists and business travelers. This is
attributable to the fact that many non ad valorem
revenues are user-based, including sales and other
special taxes, intergovernmental revenue sources,
charges, and fees.
Because some non ad valorem revenues, such as
sales taxes, are economically sensitive, pledging sev-
eral of them together may reduce the overall volatil-
ity of the bond repayment revenue stream, and give
the issuer access to more favorable interest rates.
However, a broad-based non ad valorem revenue
pledge is not, by definition, stronger than an indi-
vidual pledge. One must consider the issuer’s over-
all debt profile, as discussed below.
Many cities and counties use a secondary pledge
of non ad valorem revenues to enhance the credit-
worthiness of debt secured by a more narrow, and
possibly volatile revenue source that would poten-
tially have a weaker credit rating on a stand-alone
basis. This pledge takes the form of a direct pay-
ment of non ad valorem revenues to fund debt serv-
ice, or a deficiency make-up provision to fund debt
service or replenish a debt service reserve if the pri-
mary revenue source is insufficient.
Standard & Poor’s Ratings Services generally
views the covenant to budget and appropriate avail-
able non ad valorem revenues as being second only
to a full-faith-and-credit pledge in terms of credit-
worthiness, and has rated most such debt one notch
below an issuer’s GO bond rating if certain legal
provisions are present.
The general creditworthiness of the issuer pro-
vides a basic underpinning for its non ad valorem
bond rating. Accordingly, if no published GO rating
exists, Standard & Poor’s assigns a shadow GO
bond rating that it will release to the general public
only at the issuer’s request.
Determining the creditworthiness of non ad val-
orem debt for the purpose of assigning a rating
entails a blended approach of assessing the nature
and strength of the pledged revenue stream and
what other competing claims there may be on the
non ad valorem revenue stream. Below is a sum-
mary of the major facets on which investors
should focus.
General Creditworthiness
As in a GO bond analysis, main areas of interest
include the nature of the issuer’s economic base;
financial controls and performance; investing poli-
cies and performance; administrative factors, such
as taxing authority; and debt management, includ-
ing capital planning procedures.
Pledged revenues
Differences exist in bond/legal documents providing
for non ad valorem debt. One common thread is:
statement of the issuer’s “covenant to budget and
appropriate legally available non ad valorem rev-
enues.” Therefore, how “legally available non ad val-
orem revenues” is defined is of critical importance.
Legally available generally means that obligations
payable from one or more specific non ad valorem
sources are net of amounts necessary to fund “essen-
tial government services.” Reviewing the mix of rev-
enues and their historical performance is an
important part of the analysis. It is also important
to verify that the specific revenues under the pledge
are authorized for the duration of the debt service
obligations outstanding. The expiration of a major
non ad valorem tax source could be a significant
credit weakness. The funds subject to the non ad
valorem pledge should include at least the main gov-
ernmental fund of the issuers, which, in most cases,
is the general fund. A general fund-only pledge is
usually just as strong as one that makes no fund dis-
tinction, as most unrestricted non ad valorem rev-
enues are accounted for in the general fund.
One advantage of the general fund-only pledge,
from an issuer’s point of view, is that new sources of
revenues can be placed in other funds for other uses,
rather than automatically becoming subject to the
lien on non ad valorem revenues. However, once a
revenue is considered pledged, the issuer should not
be able to reroute it to other uses to the detriment of
bondholders. Depending on the timing of the receipt
of pledged non ad valorem revenues and when debt
service is due during the issuer’s fiscal year, a debt
service reserve fund may be appropriate.
Prior-lien obligation
Debt secured by one of the revenue sources includ-
ed in the non ad valorem pledge is seldom noted in
the non ad valorem bond resolution. It is important
that there be disclosure and analysis of all bond
issues that may have a prior lien on any of the
pledged non ad valorem revenue sources (such as a