By Sean Lentz, Senior Municipal Advisor,
Matthew Hammer, Senior Municipal Advisor,
and Brian Reilly, Senior Municipal Advisor | Managing Director

The Role of Bond Insurance & Credit Enhancement in Debt Issuance

When school districts, cities, counties and other municipalities take on large capital projects they typically issue general obligation bonds or lease obligations to finance those facilities and improvements.  Credit enhancement programs and accessing bond insurance both provide an extra layer of security to the investor. In turn, the added security results in higher credit quality for the debt, making it more attractive to investors and lowering the effective cost of borrowing.

State Credit Enhancement – School Districts

For school districts in Minnesota that are building a new school, upgrading facilities, repairing and maintaining their facilities, or need cash flow financing, a lower borrowing cost can translate into an increased borrowing capacity or a lower tax impact.  Under Minnesota Statute 126C.55, independent school districts and intermediate school districts participate by completing a free application administered through the Minnesota Department of Education (MDE) and approving their participation as part of a school board resolution.  The resolution, which typically is combined with the intent to issue municipal securities, provides for the participation in the program, use of a paying agent, and agreement to make the state whole in the case that a payment is made to investors by the State.

Bond issues, or other qualifying financings, warrant two ratings – the underlying rating of the district and the credit enhanced rating which is the rating applied to the program which is directly correlated to the State of Minnesota’s credit rating, which is current “AAA” by the three major rating agencies , which is generally higher than the issuer’s underlying rating.

Due to the reliable collection rate of property taxes and the fact that payments are levied through property taxes at 105% of the actual debt service requirement the probability of using this program is low and in fact, Ehlers does not have one recorded use of this program.  Nonetheless, the program helps districts fund essential capital improvements in a more cost-effective way by significantly reducing the risk for investors enabling districts to receive lower interest rates on their bonds.

The economics of insurance have been comparatively strong in 2024 and throughout 2025.  In 2024 and through August of this year, a little more than 8.00% of new issues by dollar amount were insured.  This is almost twice as much as the recent low of insurance penetration in 2018, when about 5.50% of new issue dollar volume was insured.

State Credit Enhancement – Minnesota Cities & Counties

Beyond public school districts in Minnesota, cities and counties can also enjoy the benefits of the state’s credit enhancement program for certain facility and infrastructure projects.  In fact, access to the program was expanded in August of this year due to legislative changes enacted during the most recent session (more on this below).  Unlike school districts, cities and counties must submit a $500 payment with their application to the Minnesota Public Facilities Authority.  There are no ongoing payments after the initial application fee.

Cities and counties can obtain credit enhancement when issuing general obligation debt for the construction, improvement, or rehabilitation of the following projects:

• Drinking water, wastewater, and stormwater facilities
• Any publicly owned building or infrastructure improvement that has received partial funding from grants awarded by the commissioner of employment and economic development related to redevelopment, contaminated site cleanup, bioscience, small cities development programs, and rural business infrastructure programs, for which bonds are issued by the authority under section 446A.087

Counties can additionally confer the guarantee of state credit enhancement to a general obligation or lease obligation to provide funds for the construction of:

• Jails, correctional facilities, and law enforcement facilities
• A courthouse or justice center, if connected to any of the above (new August, 2025)
• Social and human services facilities
• Solid waste facilities
• Qualified housing development projects as defined in MN statutes section 469.034, subd. 2

Amendments to the program in 2025 have expanded its scope and improved financing flexibility for municipalities.  The program now includes the ability of counties to credit enhance financing related to courthouses and justice centers when connected to any of a jail, correctional facility, or law enforcement facility.  In addition, the recent changes enable cities and counties to garner credit enhancement for refunding of any previously enhanced debt obligations  In order to maintain the guaranteed status on previously enhanced debt obligations, the refunding must generate “a net present value of debt service costs.”  There is no minimum savings requirement established in statute, so any net present value savings will suffice.  Prior to this change, any refunding of credit enhanced bonds by a city or county would have negated the guaranteed status, greatly diminishing the ability to refinance for savings.

Paying Agent’s Role in the Credit Enhancement Program

For free or minimal cost State Credit Enhancement programs, if an issuer knows that it will default on a bond payment, the State of Minnesota steps in to wire transfer the required funds to the paying agent, covering the payment from available cash balances. Like bond insurance, there are mechanisms in place to ensure that the State will be made whole for the payment.  For schools, in coordination with MDE, the district must repay the state, either through state aids that would have otherwise been received by the district or an additional levy over a maximum period of five years.  Additionally for other issuers, in coordination with MPFA, the county or city’s pledge becomes a general obligation of the issuer to repay the State with interest.

One of the requirements to participate in the credit enhancement program is that the issuer must engage an independent paying agent. The role of the paying agent in this process is to ensure the collection and transfer of debt payments, monitor for payment defaults, and provide notification to the State of Minnesota if payment under the credit enhancement program is needed.

Ehlers regularly takes on the role of paying agent and registrar for clients, which is much more than just collecting and forwarding debt payments. As a designated agent, we provide payment invoices in advance of  payment due dates; collect the required funds and submit payments and any required documentation to bondholders; support issuers through direct communication with the bond holding company; coordinate and respond to auditor verification letters on their behalf; and complete and submit required IRS filings for direct-pay and tax-credit bond programs.  BTSC also handles administrative tasks, such as processing required mandatory redemption notices for term bonds and optional redemption notices for full or partial calls.

Bond Insurance for Local Units of Government

For those issuers that cannot enjoy credit enhancement through a guarantee by their state or another governmental authority, bond insurance can be an effective option to reduce debt service costs.  The two major bond insurers presently underwriting municipal debt transactions are Build America Mutual (BAM) and Assured Guaranty, both of which are rated “AA” by multiple rating agencies.  Any debt that is “wrapped” by insurance carries the rating of the insurer, and, if the issuer is rated, the underlying rating of the issuer.  This means bond insurance can be especially valuable for issuers in the “A” rating category and even non-rated issues.  Bond insurers are paid an up-front premium to guarantee the timely payment of principal and interest to bondholders in the event of a payment default by the borrower.  The insurer then seeks reimbursement from the issuer.

Insurance for a new issue of municipal securities is evaluated and purchased differently based on the method of sale.  The issuer’s municipal advisor plays a key role in this regard and can assist with evaluating the cost effectiveness of this form of credit enhancement.

For a competitive sale, it’s common for the issuer’s municipal advisor to have the new issue qualified for insurance from one or both providers, leaving purchase of the policy at the bidder’s option.  The insurers review the transaction and the credit, quote a premium, and underwriters determine whether they wish to purchase the insurance.  The lowest True Interest Cost (TIC) is still controlling, so the cost of the insurance is considered when calculating the winning bid.  The issuer does have the option of purchasing insurance outright for a competitive sale.

In a negotiated sale, the issuer, municipal advisor, and the underwriter’s team evaluate the economics of insurance to deliver a net reduction in total cost of borrowing.  The analysis consists of several factors:

• The anticipated rating of the issue, or lack thereof
• The willingness of one or both insurers to provide insurance
• The premium(s) quoted
• The cost of the premium versus the reduction in gross debt service cost on a future and present value basis

The issuer’s municipal advisor will prepare the analysis using pricing indications from the underwriter and informs the issuer of any other pros and cons associated with the decision.

If your community needs assistance with either credit enhancement or bond insurance, please contact one of the authors noted above.

Required Disclosures: Please Read

Ehlers is the joint marketing name of the following affiliated businesses (collectively, the “Affiliates”): Ehlers & Associates, Inc. (“EA”), a municipal advisor registered with the Municipal Securities Rulemaking Board (“MSRB”) and the Securities and Exchange Commission (“SEC”); Ehlers Investment Partners, LLC (“EIP”), an investment adviser registered with the SEC; and Bond Trust Services Corporation (“BTS”), holder of a limited banking charter issued by the State of Minnesota.

This communication does not constitute an offer or solicitation for the purchase or sale of any investment (including without limitation, any municipal financial product, municipal security, or other security) or agreement with respect to any investment strategy or program. This communication is offered without charge to clients, friends, and prospective clients of the Affiliates as a source of general information about the services Ehlers provides. This communication is neither advice nor a recommendation by any Affiliate to any person with respect to any municipal financial product, municipal security, or other security, as such terms are defined pursuant to Section 15B of the Exchange Act of 1934 and rules of the MSRB. This communication does not constitute investment advice by any Affiliate that purports to meet the objectives or needs of any person pursuant to the Investment Advisers Act of 1940 or applicable state law. In providing this information, The Affiliates are not acting as an advisor to you and do not owe you a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of 1934. You should discuss the information contained herein with any and all internal or external advisors and experts you deem appropriate before acting on the information.