More recently, however, bank examiners have observed several community banks financing potentially riskier projects.
Over the past several years, examiners have observed a shift in smaller project financing away from capital markets to financial institutions.
During the Great Recession, some municipalities either lost their investment ratings or saw their bond insurance premium costs increase; therefore, the cost of issuing debt securities in the capital markets increased.
Generally, these projects are longer term and supported by cash flows generated from the project.
If cash flows are insufficient to meet the debt service requirements, the financial institution might be forced to restructure the transaction or obtain financial support from the municipality.
Municipalities do not guarantee this type of debt but often offer financial support to ensure that services continue to be provided to their citizens.
Construction and Financing of Self-liquidating Projects: Hearings Before the Committee on Banking and Currency, House of Representatives, Seventy-sixth Congress, First Session, on H. 7120, a Bill to Provide for the Construction and Financing of Self-liquidating Projects, and for Other Purposes ...
Many banks have viewed lending to municipalities as a relatively low-risk activity and an opportunity for the bank to earn other business from the municipalities, including deposits, cash management, and wealth management.
Historically, loans to state or local municipalities were viewed as low-risk lending opportunities because municipalities frequently guaranteed repayment, which was often based on the state or local government's taxing authority.
The so-called Great Recession of 2007-2009 and its aftermath have taken a toll on the financial state of many municipalities, making repayment less certain than it once may have been.
This article examines municipal lending by community banks, including common types of credit facilities, recent trends, and effective credit risk management practices.
Various types of loans are made directly or indirectly to municipalities.
These loans are repaid through general cash flows or through specific revenue streams, such as water and sewer fees or stadium and parking fees.
In the past, community banks typically financed small municipal projects, such as purchasing new equipment or vehicles or providing a working capital line of credit to offset the seasonality of the municipality's cash flow.