Thursday, March 16, 2006

Debt caps

There is a constitutional debt limit in the Commonwealth.

In Article X, section 9 of the Constitution of Virginia says that only 15% of the average of the revenue derived from income and retail sales tax for the three fiscal years preceding the incurring of the debt can be used to pay off debt. The constitutional limit is 15%.

Guess what the operating limit or internal cap is? Only 5%.

Want to know what the most recent interest rate is that Virginia got for a bond issuance is?
Try 3.7%.

Want to know how much capacity we have under the 5% cap? Try about 840 million per year for 10 years. The Senate legislation this year for higher education bonds, I think, use up some of that for the next fiscal year.

As a member of a small family business of 45 employees, I have grown up knowing the responsibility of paying off debt. I have also grown up knowing that sometimes it is okay to finance asset development. Naturally, I am not a fan of financing depreciating assets like automobiles and we always try for the shortest terms available on the trucks and cars at our company. Assets that appreciate at rates above the financing rates are usually a pretty good investment. Housing is highly profitable now for this very reason. Finance for x% versus ROI of 4x% is a pretty good deal.

In our business, we are building a new warehouse because of market growth in our northern branch. Because we do not have the cash sitting around to pay for this straight away, we are going to the bank for a loan. We would die for 3.7% rates, but there is less risk with government backed bonds and therefore VA gets better rates. We take that risk because we think that over the long haul, that investment will pay off for that part of our business. Recently, we have also added some very expensive capital equipment including a robot and that too was financed with our bank. Operating expenses are never financed as that is a BIG no-no.

So, what is the point? Virginia is a balanced budget state that does not finance operations with debt. This is not the federal government!

The Senate wants to issue debt for higher education and the House wants to issue some for transportation. Some areas are paid for with cash and some are not. The good news is that both plans have dedicated funding streams which will maintain the coveted AAA bond rating. Both will provide necessary improvements in our intellectual and transportation infrastructure.

If we are growing at rates that are consistently double and triple the prevailing lending rates, does it make sense that some, not all, of our financing can be accomplished with some debt? This will provide the necessary infrastructure that will continue to keep Virginia's economy growing. To be sure, interest rates that are in the 8-10% range would not be a wise move at this point, but 3.7% is still a great rate and should not be so quickly dismissed.


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