Debt Service Payment Procedures

Type: 
Best Practice
Background: 

Issuers of government debt have a fiduciary responsibility to manage their funds in a manner that assures timely and accurate payment of debt service principal and interest on all forms of indebtedness, including bonds, notes, loans, etc. That responsibility also includes full use of funds for the benefit of the government until payment due date.

Electronic fund transfers are the recommended form of payment allowing governments to ensure timely payment no later than the payment due dates in order to retain use of their funds until that date. Use of electronic fund transfers standardizes payment streams, reduces credit and liquidity risk, provides a complete audit trail, improves efficiency, and reduces loss of the use of funds.

Issuers must establish a plan for the allocation and investment of debt service funds to assure availability of funds. Issuers must also ensure timely payments and negotiate terms with counter-parties that serve both government and bondholders’ needs in accordance with financing documents.

Failure to make timely and accurate debt service payments generally results in a default, which could trigger severe negative consequences for issuers, such as debt acceleration, financial cost, and impairment or loss of market access. In addition, the defaulted issuers will have to post a Material Event Notice on the MSRB’s EMMA page to disclose to investors their failure to meet their debt service obligations.

Recommendation: 

To ensure that debt principal and interest payments are made timely, accurately and on a cost effective basis, the GFOA makes the following recommendations to state and local governments.

  1. Governments should establish procedures, including identification of backup staff and continuity plans, that identify parties responsible for making debt service payments and ensure their fiduciary and operational responsibilities are fulfilled. Bond documents typically require issuers to hire a trustee/fiscal agent/paying agent to ensure payments of debt service. The negotiation of contract terms with a retained trustee/fiscal agent/paying agent  should serve the government, the trustee/fiscal agent/paying agent, and the bondholders and include:
    1. requirement for timely payment or transfers of funds on or before the actual payment dates as required by financing documents;
    2. full utilization of funds by the government until the due date;
    3. requirement for use of electronic fund transfer throughout the payment process; and
    4. requirement that all parties execute transactions in the most cost efficient and effective manner.
  2. Issuers should ensure that priority of payments, commonly referred to as “flow of funds”, required by bond indentures is followed.
  3. Issuers should require that trustees/fiscal agents/paying agents invoice the government for debt service payments a minimum of 30 days prior to the due date. Issuers should understand and monitor changing debt service requirements when dealing with variable rate debt, bonds that include federal subsidies, refundings, and situations that rely on funding from third-parties.  Issuers should validate invoices against scheduled or expected debt service payments and ensure sufficiency of funds particularly in a rising interest rate environment.
  4. Issuers should use electronic fund transfer to assure transfer to the trustee/fiscal agent/paying agent no later than the payment due date. If payment is made by check, issuers should ensure the check is sent no more than five (5) days prior to the payment date through a guaranteed delivery service.
  5. Issuers should ensure that all parties to the transaction (internal and external) are kept informed of the established procedures.
  6. If a debt service payment has been missed, issuers should:
    1. take an immediate action to remedy the situation by making the required payment as soon as possible;
    2. notify their trustee, bond counsel and municipal advisor and achieve clear understanding of the consequences of the missed payment; and
    3. post a Material Event Notice on the MSRB’s EMMA webpage.
References: 

GFOA Best Practice, Debt Management Policy, 2012.

Approved by GFOA's Executive Board: 
March 2018