What Is Net Debt to Assessed Valuation?
The term net debt to asset valuation refers to the total amount of a municipality's debt compared to the value of total assets that are assessed or purchased for a municipal bond issue. Net debt to assessed valuation allows investors to determine the overall quality of a municipal bond issue.
This metric is important because it tells investors and analysts the level of risk associated with municipal bond issues. Bonds with lower ratios indicate a lower likelihood of default, which means they come with less risk and a higher bond rating. The reverse situation occurs when a debt issue comes with a higher ratio.
- Net debt to asset valuation measures a municipality's debt compared to the value of total assets that are assessed or purchased for a municipal bond issue.
- The net debt to asset valuation allows investors to determine the quality of a municipal bond issue.
- This metric tells investors and analysts the level of risk associated with municipal bond issues.
- Lower debt means a lower degree of default risk, which means a higher bond rating and vice versa.
- Investors can use other debt ratios, such as net-overall debt, to assess the relationship between an issuer’s outstanding debt and other factors such as its tax base, income, or population.
Understanding Net Debt to Assessed Valuation
There are many types of municipal bonds but the broadest categories are general obligation(GO) bonds and revenue bonds. GO bonds form the basis from the credit of the issuing state or local government and their ability to tax. Revenue bonds usually are issued to fund specific projects and are repaid by particular taxes or by the revenue generated by the project.
Although bonds are considered to be among the safest investments, they still come with some risk. There may be a risk to the investor if the issuer defaults and can't repay their principal investment. So if you're considering putting your money in a municipal bond, how do you know whether your principal will be paid back to you?
You can use one or more metrics that help determine the risk of default. Net debt to asset valuation is one of the factors that is used to determine the credit quality of a municipal bond issue. It is expressed as a ratio. Net debt shows a municipality's overall financial situation by subtracting the total value of the city's obligations and debts from the total value of its cash, cash equivalents, and other liquid assets, in a process called netting.
As noted above, the lower a municipality's debt is relative to the assessed value of its property the less risky its bonds are deemed to be. There is less risk of the government being unable to finance repayment of the bond issue if they have low relative debt. A higher ratio could indicate that a sale of the underlying assets might be insufficient to pay the debt.
You can figure out net debt to assessed valuation for a municipal bond issue using the following formula: short-term debt + long-term debt - cash and cash equivalents ÷ total estimated market value of property or assets.
Debt ratios are comparative statistics showing the relationship between the issuer’s outstanding debt and factors such as its tax base, income, or population. These ratios are primarily useful when looking at GO bonds or other tax-supported debt.
Some of the more commonly used ratios in addition to net-overall debt to asset valuation include:
- The net-overall debt to estimated full valuation compares the net value of a municipal bond issue to the expected market value of the real estate secured by the debt.
- A net-overall debt per capita is the amount of an issuer’s debt outstanding divided by the population residing within the issuer’s jurisdiction. It indicates the issuer’s credit position because it compares the proportion of debt, borne per resident there, with that of residents in other jurisdictions.
- The tax-supported debt to personal income would be comparing a state’s level of debt to the total personal income of its residents, which measures the state’s ability to repay its obligations because it indicates its ability to generate revenue.
Example of Net Debt to Assessed Valuation
Let's use a hypothetical example to show how net debt to assessed valuation works. Assume the city of Normal has $200 million in short-term debt, $200 million in long-term debt, and $20 million in cash and cash equivalents.
The market value of the city's real property such as buildings it owns, the parks and recreation lands, public utilities such as water and sewage services, and personal property like equipment and vehicles is $500 million.
If we use the formula above, the city's net debt to assessed valuation is 0.76 ($200 million + $200 million - $20 million) ÷ $500 million.