AN INCOME-EXPENDITURE APPROACH TO MUNICIPAL CREDIT ANALYSIS

252 Pages·09.22 MB·English

by  BOWYER, JOHN WALTER, JR

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Bowyer, John Walter, Jr.
AN INCOME-EXPENDITURE APPROACH TO MUNICIPAL CREDIT
ANALYSIS
Indiana University, Graduate School of Business D.C.S. 1950
University
Microfilms
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AN INCOME-EXFENDITURE APPROACH TO
MUNICIPAL CREDIT ANALYSIS
BY
JOHN W. BOWYER, JR. r :: x
A D issertation Submitted in P artial Fulfillm ent for the
Degree of Doctor of Commercial Science in*.fche
School of Business of Indiana Univers'A&y
Indiana U niversity
1950
V
ACCEPTANCE
0“
This D issertation has been accepted In p a rtial fulfillm ent
of the requirements for the Degree of Doctor of Commercial
Science in the School of Business of Indiana U niversity.
Date L (&r*
DeanA School of Business
H i
Foreword
Over a long period of years, Investors in municipal
bonds have developed several techniques of municipal credit
analysis based on different concepts of how the a b ility of a
m unicipality to service its debt can best be appraised. Tfie
two techniques in common use are usually referred to as the
"financial statement" technique and the "economic background
analysis" technique.
The financial statem ent technique is based on the
proposition that the credit position of a local government
unit is determined by relatin g the principal amount of debt
outstanding to the value of rea l property subject to taxation.
The economic background analysis technique, on the other hand,
is based on a broader view in that the a b ility of the local
government to pay its debt is prim arily influenced by the
general wealth and prosperity of the community.
These techniques have certain obvious shortcomings
and lim itations which make them inadequate. The financial
statement technique is much too narrow in its conception of
the influences upon local government credit position. Real
property is regarded as almost the sole source of funds for
the payment of debt and little or no consideration is given
to the more basic factors which affect the value of real
property and the a b ility of the property owners to pay taxes.
Sim ilarly the lia b ilitie s to be paid out of taxes are too
narrowly construed in that only debt is related to property
iv
values. While in fact a ll the expenses of local government
operations of which debt service charges is only a portion
must be paid from local government revenues.
The broader approach to the determ ination of local
government credit position, the economic background analysis,
has the virtue of seeking to appraise more fundamental in ­
fluences on the a b ility of local governments to pay th eir
debts. However, as generally conceived, conclusions drawn
from the use of th is technique are likely to be so broad and
general astto be of very lim ited usefulness. A fter these
general conclusions as to the economic potential of the com­
munity are made, there is no means of d irectly relating them
to the requirements of the community for debt service and for
other local government expenditures. As a consequence, the
economic background analysis does not yield very accurate or
comprehensible resu lts.
A fter considerable study of the conventional techniques
of local government credit analysis, the idea was conceived
that more accurate appraisals of credit position could be
obtained by actually measuring the aggregate income of a
local government area and relatin g this small area income to
the amount of revenue required for aggregate local government
expenditures. The aggregate income of the local government
area is the source of funds for payment of local government
debt service charges and operating expenses as well as for
meeting the personal requirements of the residents.
V
Consequently, the a b ility of the local government to pay its
debts and to defray its operating expenses is essen tially a
question of its a b ility to divert from the area income suf­
ficien t funds for those purposes. Therefore, the establish­
ment of the relationship of area income to local government
revenue and the resid en t’s personal expenditure requirements,
in principle, provides a much more direct and logical way of
reasoning about local government credit position than either
of the two conventional approaches.
There are, however, no established techniques for
estim ating small area incomes or for relating such estim ates
to the financial requirements of local government. This,
dissertation represents an effort to develop such techniques
and to determine whether the techniques developed make pos­
sible a practical and useful application of the income-
expenditure approach to municipal credit analysis.
Chapter I describes and appraises the conventional ap­
proaches to municipal credit analysis. In Chapter II, there
is an examination of the principles of the proposed income-
expenditure technique and the problems involved in developing
it. Chapter III is devoted to the problem of estim ating email
area Incomes and Chapter IV is concerned with an examination
of the problems of projecting these income estim ates into the
future. In Chapter V, a measure of the fisc al capacity or
potential a b ility of the local government to pay current
operating expenses and debt service charges is developed and
presented. Chapter VI is concerned with the secular and
Vi
cyclical influences cm the aggregate expenditure load of
local governments. Chapter VII presents tne problems of
actually making the credit decision when the income-
expenditure analysis technique is used and an evaluation of
the p racticality and shortcomings of the technique.
Irii
Preface
This study has as its primary objective the determina­
tion of whether small area Incomes can feasibly be used as
the primary tool in making municipal credit analyses. It is
designed to test the idea that an index of a local govern­
ment’s a b ility to pay debt service charges and operating
expenditures could be derived from the aggregate income of
the local government area.
Although there are presently available techniques of
municipal credit analysis, it was not fe lt that they provide
accurate and comprehensible resu lts. Consequently, this
exploratory study was undertaken in an attem pt to develop an
improved technique of municipal credit analysis.
The w riter is indebted to Professor H. C. Sauvain,
School of Business, Indiana U niversity, and to other members
of the sta ff of Indiana U niversity for the many suggestions
and criticism s which have been contributed in making th is
study. In addition, the w riter wishes to acknowledge the
data and suggestions provided by Dr. F. L. Bird, Dun and
B radstreet, Inc., Robert Graham, United States Department of
Commerce and Paul Harvey, Indiana State Board of Accounts.
John W. Bowyer, Jr