26 ENVIRONMENTAL ENGINEERING
plus interest. GO bonds are backed by the basic taxing authority of the issuer; revenue
bonds are backed solely by the revenue for the service provided by the specific project.
The GO bond is generally preferred since the overhead costs of financing GO
bonds are lower and their greater security allows them to be offered at a lower rate
of interest. Some states are constitutionally prevented from issuing GO bonds or are
limited in the quantity they can issue, and cities may have to resort to revenue bonds.
Nevertheless, most bond issues for wastewater treatment projects are GOs.
Most municipal bonds carry a credit rating from at least one of the private rat-
ing agencies, Standard & Poor’s or Moody’s Investor Service. Both firms attempt to
measure the credit worthiness of borrowers, focusing on the potential for decrease
on bond quality by subsequent debt and on the risk of default. Although it is not the
sole determinant, the issuer’s rating helps to determine the interest costs of borrowing,
since individual bond purchasers have little else to guide them, and commercial banks
wishing to purchase bonds are constrained by federal regulations to favor investments
in the highest rating categories.
Of the rating categories used, only the top ones are considered to be of invest-
ment quality. Even among these grades, the difference in interest rates may impose
a significantly higher borrowing cost on communities with low ratings. During the
1970s, for example, the interest rate differential between the highest grade (Moody’s
Aaa) and the lowest investment grade (Moody’s Baa) bonds averaged 1.37%. Such
a differential implies a substantial variation in financing costs for facilities requiring
extensive borrowing.
To highlight the importance of financing costs, consider the example of a city plan-
ning a $2 million expenditure on an incinerator to serve a publicly owned (wastewater)
treatment works (POW) with a capacity of 15 million gallons per day (mgd). Under
one set of assumptions, such a facility would support a population of roughly 75,000
that would bear anywhere from 12.5 to 100% of the total cost, depending on what
portion of the capital expense state and federal agencies agreed to pay. Under the more
conservative assumption, this would amount to $250,000. Assuming that the capital
is raised through one Aaa bond issue amortized over 25 years at an interest rate of
5.18%, the interest payment over the entire borrowing period would total $212,500. If
the Baa rate were 6.342, the interest payments would amount to $262,000. As a rule
of thumb, total interest payments are roughly equal to the principal and are sensitive
to the interest rate.
The rating may also determine the acceptability of bonds on the market. A city
with a low or nonexistent rating might find that credit is simply not available. The
fiscal problems of small communities are particularly sensitive to the rating process,
which places lower ratings on small towns on the basis of an ill-defined “higher risk
of default,” despite the lack of supporting evidence. Hence, small towns must often
endure higher interest payments. The problem is compounded by the higher average
cost of small bond issues owing to certain fixed underwriting fees associated with
buying and selling the bonds.
Despite the availability of GO financing and good credit, municipalities may face
difficulties in raising capital because of the state of the market, while some borrowers
may be precluded from borrowing altogether. Two trends are of particular significance.