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Ocean City

Bonds to be issued for 10-year term given rising interest rates

(Oct. 4, 2013) The City Council this week unanimously approved a recommendation to issue 10-year, instead of 20-year, bonds for the city’s debt this year, taking steps to improve its long-term financial position.

The move comes as part of a nationwide expectation of higher interest rates in the coming years, as the Federal Reserve continues to talk about loosening its grip amidst a slow economic recovery.

As such, city Finance Administrator Martha Bennett said, “there’s a much bigger market for 10-year bonds than there is for 20-year.”

Paying back its borrowed money, plus interest, over 10 years instead of 20 will cost the city more in the short term, but result in a massive long-term savings and an improvement of the city’s solvency in the eyes of financial auditors.

The city plans to borrow $12.7 million at the end of this year for upcoming projects. The lion’s share of this – almost $8.5 million – is for the performing arts theater expansion at the convention center. This debt is to be repaid entirely out of the city’s food tax, which is authorized by the state exclusively to fund its partnership with the municipality in running the convention center.

That financing, per the state, was already set to be issued as a 10-year bond.

The remaining money will be borrowed against the city’s general fund, supported mostly by property tax revenues, and against the wastewater fund. This fund is financed entirely by the city’s sewer and plumbing fees and allows the wastewater division to operate independently from the general fund.

The city has historically issued 20-year bonds when borrowing for these funds.

According to Bennett’s calculations, substituting with a 10-year bond will increase the city’s debt payments for the next 10 years between $118,000 and $124,000, depending on the calculation used, for the general fund. After this period, however, the bond will be paid back, and the city will not have to spend the average of $225,000 per year over the next 10 years that it would’ve had to continue to pay on a 20-year bond.

This yields a total savings of over $1 million for the general fund. The smaller-value wastewater bond would see a savings of roughly $470,000.

The bottom-line savings is due to the projected difference of interest rates between 10-and 20-year bonds. The city’s bond counsel projects the former at around 3 percent, versus 5 percent for the latter.

This difference is due to investors’ willingness to take a lower profit on a shorter bond, which ties up their money for less time. That effect is amplified in a time when interest rates are expected to rise, as investors do not want to commit to a long-term investment at a given rate if they believe a better rate will soon become available.

When this happens, lower-return bonds lose their attractiveness for trading and become massive liabilities.

“If you’re an investor, a 10-year bond is much better in today’s environment given rising interest rates,” Councilman Brent Ashley said.

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