Industry Insights

New Debt Disclosures Proposed

August 2017

Municipal debt traditionally has been viewed as a stable, low-risk investment. Recent defaults and near defaults, e.g., Detroit and Puerto Rico, have shaken this conventional wisdom. Investors have voiced concerns about inconsistencies in existing disclosures in financial statements and limited information to adequately assess risk levels. The Governmental Accounting Standards Board (GASB) recently issued an exposure draft to improve debt disclosures in governmental financial statements. Comments are due September 15, 2017.

Background

Existing guidance for notes to the financial statements requires the following general disclosures for outstanding debt:

  • Changes in the amount of outstanding debt during the reporting period, as part of the overall disclosure of changes in long-term liabilities, including amounts due in one year (GASB Statement No. 34)
  • Debt service requirements for each of the succeeding five fiscal years and in five-year increments thereafter until maturity (GASB 38)
  • The terms by which interest rates change for variable-rate debt (GASB 38)

Additional note disclosures required for certain debt-related transactions include:

  • Changes in short-term debt during the reporting period, including the purpose for which it was issued (GASB 38)
  • Short-term obligations (GASB 62)

Many governments frequently provide additional details to comply with U.S. Securities and Exchange Commission disclosure requirements or the general reporting requirement to disclose material items to prevent a misleading financial statement. This information may include original amounts, outstanding amounts, issuance dates and final maturities of individual issuances of general obligation, tax-backed and revenue bonds; however, this information is not required by current GASB standards.

In recent years, governments have increasingly satisfied their financing needs through direct bank loans rather than issuing municipal bonds. Credit rating agencies and bond market regulators have highlighted situations where governments have either provided inadequate disclosure regarding their direct borrowing arrangements or inappropriately classified direct loans as other types of debt in their financial statements.

Definition of Debt

GASB proposes the following definition of debt for financial statement disclosures:  “a liability that arises from a contractual obligation to pay cash (or other assets that may be used in lieu of payment of cash) in one or more payments to settle an amount that is fixed at the date the contractual obligation is established.” Leases and trade accounts payable are specifically excluded from this definition. The narrow definition was intended to exclude liabilities like pollution remediation obligations, landfill closures and asset retirement obligations for which the amount or payment dates are undetermined at inception; therefore, no specific scope exclusion was warranted. GASB concluded that interest to be accrued and subsequently paid, e.g., variable-rate debt, or interest to be added to the obligation’s principal amount, e.g., capital appreciation bonds, would not preclude such instruments from being considered debt.

Disclosures

In addition to other required information noted above, a government should disclose, in notes to financial statements, summarized information about these items:

  • Amount of unused lines of credit
  • Collateral pledged as security for debt
  • Terms specified in debt agreements related to significant:
    • Events of default with finance-related consequences
    • Termination events with finance-related consequences
    • Subjective acceleration clauses

Governments would be required to separate information on direct borrowings and direct placements of debt from other debt. There’s no requirement to segregate short-term debt from long-term borrowings for these disclosures.

GASB considered but rejected even more comprehensive disclosures, including date of issuance, maturity date, amounts borrowed for individual borrowings, interest rates on individual borrowings and weighted-average interest range for outstanding debt.

Effective Date & Transition

If adopted, these requirements would be effective for reporting periods beginning after June 15, 2018. Earlier application would be encouraged. Retrospective application would be required, if practicable.


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