WASHINGTON, April 22 (Reuters) - A state or local government that guarantees debt should list the agreement as a liability on its financial statements if it may have to make a payment for it in the future, the board that sets accounting standards for the U.S. public finance sector said on Monday.
States, for example, occasionally guarantee bonds sold by local governments and some local governments back mortgage loans to individuals.
Because such credit support could stress the governments’ finances if they have to step in and make payments on the debt, those governments should put the agreements in their financial statements, the Governmental Accounting Standards Board said.
It emphasized in its guidance that a government should recognize the liability “when it is more likely than not that the guarantor will be required to make a payment to the obligation holders under the agreement.”
In the same light, governments receiving the credit support should disclose the guaranties, GASB said, because they represent “a potential reduction of a government’s obligations.”
“In the current economic environment, investors are increasingly seeking credit enhancements and assurances, including financial guarantees, to minimize the possibility of nonpayment,” said GASB Chairman Robert Attmore in a statement. He added that the disclosure “will enable financial statement users to better assess the probability that governments will repay obligation holders.”
Issuers once purchased bond insurance to raise the credit ratings of their debt and assure bond buyers they would be paid. Insurers had also backed risky mortgage debt, and the industry was ravaged during the housing crisis.
Now issuers are turning to alternatives such as banks’ letters of credit or selling bonds without any guaranties.
The amount of new insured debt in the U.S. municipal bond market totaled $2.1 billion in the first quarter of 2013, a 41.7 percent drop from the same period in 2012, according to Thomson Reuters data.
Meanwhile, Moody’s Investors Service has put one of the few remaining insurers, MBIA Inc., on review for possible downgrade.
Last week, Morningstar Inc. said state permanent funds, the debt assurance programs created by state law that operate similarly to endowments, are the strongest types of state credit enhancement. They provide “an additional level of security” to bondholders while also lowering the costs of financing for the municipal issuers, Morningstar said.
States also provide credit assurance for local municipalities through guarantee, appropriation and intercept programs, according to Morningstar.