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Two Powerful Cash Management Optimization Tools

Updated: Jun 14, 2023

Public agencies must ensure its community's needs are being met by efficiently utilizing capital while keeping the community's best interests in mind. In this article, we explore two powerful strategies that can bring economic efficiency to an agency's cash management decisions.


PAY-GO VS. TAX-EXEMPT FINANCING


Many public agencies utilize cash reserves (aka pay-go strategy) to pay for equipment, facilities, and other capital improvement projects to avoid the interest expense associated with debt. However, the Weist Law team has learned over our 30+ years of practice, there is often a higher cost of waiting (especially in an uncertain market environment) in comparison to financing. Tax-exempt debt financing shouldn't be viewed as a "last resort" option, but rather as an effective tool for achieving community goals.


While paying with cash may appear to minimize expenses, public agencies typically experience higher asset costs and potentially forgo future revenues during the savings period, resulting in a lower return on investment. A public agency's best practice should be to consider utilizing cash to pay off existing debt/liabilities, and leveraging financing for large projects.


In this example, a public agency needs $10,000,000 for a project. The municipality can save $1,000,000 every year in reserves for the project over ten years with a $10,000,000 end goal. However, as discussed above, labor and material costs increase over that same time period at around 3% (presently) annually leaving the total project cost at ~$13,500,000 resulting in a ~$3,500,000 cash shortfall. The light green line shows payments for a $10,000,000 financing at a conservative 3.4% tax-exempt interest rate. Over the same ten year span, the total debt service payments amount to around ~$12,000,000. A ~$1,500,000 surplus is generated from financing versus waiting to self-fund with cash reserves. Not only do you get to start building now, but you save by locking in labor and material costs at today's prices.


Also, by financing and spreading the cost of projects that have greater average useful lives over a longer period of time, present ratepayers enjoy the benefits from day1 (and are not having to foot the bill for future beneficiaries), thereby creating an equitable balance between those who pay and those who benefit (also referred to as intergenerational equity).


Saving reserves for an expensive piece of equipment or a large capital project is a moving target due to ever-increasing labor, material costs, and the rate of inflation--presently averaging over 3% annually. The chart below sets forth additional factors to consider when deciding rather to use a pay-go approach or a tax-exempt financing approach.



UTILIZING AVAILABLE RESERVES TO PAY HIGH-INTEREST RATE LIABILITIES


Paying off high-interest rate liabilities with available reserves or surpluses while borrowing at lower tax-exempt rates is a winning strategy for public agencies of all sizes. This strategy is comparable to a mortgage, where a homeowner chooses to finance the price of a home while using cash on hand to pay off high-interest debt such as credit cards or auto loans. Because CalPERS unfunded accrued liabilities (or "UAL") is equivalent to a 6.8% high-interest rate debt, this strategy works perfectly, but it also works for other forms of high-interest debt as well.


The chart below outlines a comparison of the interest payments on CalPERS unfunded pension liabilities in the amount of $1mm and the interest payments on $1mm of tax-exempt debt--assuming that an agency has $1M to spend on either UAL or a capital project.

As you can see, there are significant benefits of paying off your highest-yielding debt when you have available revenues and opting to use tax-exempt financing for your capital project. It is important to note that there are several IRS considerations that must be considered prior to implement this strategy. If you are considering any of the strategies mentioned in this article, please allow Weist Law an opportunity to provide you with further guidance and assistance.


Read more about this strategy by downloading our informational brochure below.


Cash Management Tools
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Download PDF • 2.35MB

Weist Law takes a holistic approach to consulting public agencies throughout California. Most members of our team are both attorneys and registered municipal advisors able to provide robust legal and financial guidance for your projects and financings. If you would like to learn more about the strategies mentioned in this article or any other public financing matter, you can schedule a no-obligation zoom meeting directly on our scheduling calendar. We would love to learn more about how we can help you generate savings and create a healthy financial future for your agency.

 

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact a designated Weist Law representative. This material may be considered advertising under certain rules of professional conduct.

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