GASB Statement No. 87, Leases has gotten a lot of attention over the last year, but for some states and local governments, GASB Statement No. 91, Conduit Debt Obligations (GASB-91) has started to become the latest hot topic in the government accounting world.
What is GASB-91?
GASB-91 clarifies decades-old GAAP, the outcome of which may result in debts recorded in some instances and in other instances, the opposite. Implementation of GASB-91 may involve communications to bond counsel and corporate trustees as well.
What is Conduit Debt?
Solely for financial reporting purposes and not for legal purposes, GASB-91 defines conduit debt as “a debt instrument issued in the name of a state or local government […] that is for the benefit of a third party primarily liable for repayment of the debt instrument.”
The state or local government that issued the debt is known as the issuer. The third party (or parties) that is primarily liable for repayment may be other governments, nonprofits, or for-profit organizations. These entities are known as third-party obligors.
Where the decision gets tricky is identification of Conduit Debt Obligations (CDOs) due to double–negative language within GASB-91. Per GASB-91, a CDO has all the following elements:
- There are at least three parties involved: (1) an issuer, (2) a third-party obligor, and (3) a debt holder or a debt trustee. There may be more than one third-party obligor, debt holder, or debt trustee.
- The issuer and the third-party obligor are not within the same financial reporting entity,
- The debt obligation is not a parity bond of the issuer, nor is it cross-collateralized with other debt of the issuer. (Parity bonds have equal rights to the collateral as other bonds issued under a common bond indenture. Cross–collateralization occurs when an asset collateralizing an existing debt is used for a second debt).
- The third-party obligor or its agent, not the issuer, the proceeds from the debt issuance.
- The third-party obligor, not the issuer, is primarily obligated for the payment of all amounts associated with the debt obligation (debt service payments).
Every previous element must be met to determine if a CDO is present. The third element is the hardest to determine.
A word of caution: Counsel may need to determine whether parity bonds and/or cross-collateralization are present. The other elements should be identifiable by issuers.
Why is this Determination Important for Issuers?
Issuers such as the of finance authorities may have CDOs, may not have CDOs, or may be unsure.
- If a CDO is present, GASB-91 relieves the issuer from reporting a liability for the debt unless there is some form of circumstance that causes the issuer to support debt service payments for that CDO. This may occur when an obligor is in bankruptcy, breaches a contract, experiences financial difficulties and similar. The amount of the liability (and expense) is measured at the discounted present value of the debt service expected to be incurred by the issuer.
- If a CDO is NOT present, a liability for the debt will be reported (if not already presented). The debt would be presented like all other debts of the issuer.
Why is Determination Important for Government Obligors?
It is common for governments to be obligors involved in CDOs. Public housing, colleges, universities, school districts, water, sewer and many other operations all may be obligors. Many of the agreements signed with issuers by government obligors may be titled ‘leases’ to circumvent legal restrictions on debt.
Reporting may change if a CDO is present.
- If a CDO is present, government obligors would report their portion of the CDO as a liability. However, this is not in GASB-91. The contract must be understood to determine if the government has a liability in accordance with existing GAAP, which is likely. If classified currently as a lease and the government is using the funds to finance a capital asset such as a treatment plant, the lease liability would need reclassification to a note payable or similar.
- If a CDO is not present, government obligors will report their portion of the debt also as a liability if they have little or no discretion to avoid payment. This is also not in GASB-91, however, there is debt service due to at least a trustee, which means recognition of a liability.
Note Disclosure Strictly for CDO Issuers
GASB-91 requires note disclosure by CDO Issuers including general description of the issuer’s CDOs and any related commitments made to obligors (which may be limited or voluntary). The commitment disclosure should also include the legal authority and limits for extending the commitments, the time of the commitments and arrangements for recovering payments from obligors (if any).
CDO issuers with such commitments would also disclose the aggregate outstanding principal amount of all CDOs that share the same commitments at the end of the reporting period.
If the CDO issuer has incurred a liability due to a commitment being exercised, additional disclosure is required including beginning and end of period balances, increases and decreases, cumulative payments made on the liability and amounts expected to be recovered from obligors.
If not a CDO, issuers would report debt information like all other debts.
The second article in our GASB-91 Conduit Debt Obligations series covers this topic more in depth. It includes more information about when CDOs are issued, how to report if construction or acquisition of a new capital asset occurs.
Despite the complexities, our team of advisors can help you understand GASB-91 Conduit Debt Obligations and how it affects your government entity.