2006 Headlines from The Bond Buyer...
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December 2006
Seminole Tribe Receives Negative IRS Rulings
Posted on Friday, December 08, 2006
By Alison L. McConnell
Be Wary Of Bid-Rigging, Players Warn
Posted on Wednesday, December 13, 2006
By Matthew Hanson
Enforcement: Court Documents Show What Bid-Rigging Looks Like
Posted on Tuesday, December 19, 2006
By Matthew Hanson
California Cities Eye Renewable Energy Utilities
Posted on Friday, December 15, 2006
By Jackie Cohen
Enforcement in Limelight
Posted on Tuesday, December 26, 2006
By Alison L. McConnell
Seminole Tribe Receives Negative IRS Rulings
Posted on Friday, December 08, 2006
Source: Bond Buyer
By Alison L. Mcconnell
Tax-exempt bond proceeds lent by the Capital Trust Agency to the Seminole Tribe of Florida were improperly used to finance a hotel and convention center because those facilities do not represent essential government functions, according to an Internal Revenue Service technical advice memorandum.
Two TAMs were disclosed Wednesday as part of a material-event notice issued by the agency and the tribe. The memos apply to $345 million of Series 2002 revenue bonds, which have been preliminarily declared taxable by the IRS' tax-exempt bond office. Proceeds from the sale, along with other funds, financed the Hard Rock Hotel and Casino, as well as related convention center facilities, in Hollywood, Fla.
The agency's counsel, Neil P. Arkuss of Edwards Angell Palmer & Dodge LLP in Boston, was traveling and unavailable for comment yesterday. IRS officials declined to discuss the case.
Merrill Lynch & Co. and JPMorgan underwrote the Seminoles' 2002 deal, which consisted of $290.6 million of Series A bonds, $25 million of Series B bonds, and $29.4 million of Series C bonds.
Orrick, Herrington & Sutcliffe LLP was special tax counsel and "has not withdrawn or modified its opinion" since the bonds were issued, according to Wednesday's notice, filed with the nationally recognized municipal securities information repositories. Orrick attorneys declined to comment on the notice and the TAMs.
The tax-exempt tribal finance sector, while relatively small compared to other areas of the municipal market in terms of issuers and volume, has seen plenty of contentious debate in recent years over what some Indian tribes, issuers, and attorneys call an unfair, even biased interpretation of existing statutes by the IRS' tax-exempt bond office, which audits municipal bond deals.
Tax code rules, laid out in Section 7871, treat tribes as states for purposes of tax-exempt bond issuance, provided that all bonds are issued in the exercise of an "essential government function." Tribes have been at odds with the IRS over whether golf courses, hotels, convention centers, casinos, and other facilities qualify under that requirement.
For conduit financings, in which a state or local government or municipal authority sells tax-exempt bonds and loans the proceeds to a tribe, the rules are not quite as clear. IRS enforcement personnel have historically taken the stance that conduit financings must also be done for an essential government purpose of the tribe. The tax-exempt bond office has also argued that, in accordance with the legislative history that generated the current regulations, tribes must not use tax-exempt bonds to finance activities that are commercial or industrial in nature.
The agency has said its chief counsel division will soon propose regulations that are expected to support that view, limiting tribal finance to noncommercial and non-industrial activities customarily performed by state and local governments, including roads, schools, and government buildings. An activity would qualify as an essential government function if there are "numerous" state and local issuers with general taxing powers conducting the activity and financing it with tax-exempt bond -- issuers that have been doing so "for many years," according to a notice of proposed rulemaking issued by the agency in August.
The TAMs, which are also issued by the IRS' office of chief counsel rather than the enforcement division, appear to support field agents' and managers' interpretations of the current regulations. The first memo concludes that the conduit financing will only work if the tribe is using financing an activity that qualifies as an essential government function, regardless of whether it issued bonds or borrowed the proceeds.
Sources said yesterday that the first TAM is nearly identical to a memo issued recently for the Cabazon Band of Mission Indians, which sought advice about a 2003 hotel and convention center deal that is also under IRS audit.
The second Seminole TAM concludes that "the operation and construction of the project" -- the hotel and convention center -- is not an exercise of an essential government function.
"The tribe has presented evidence that over the period beginning in 1995 state and local governments used [munis] to finance 15 large, urban hotels connected to convention centers," the TAM said. "Although hotels of this type may be comparable...we do not find ownership and operation of such large urban facilities to be either sufficiently prevalent or longstanding...to be considered an essential government function."
Additionally, "although the tribe observes that there are a small number of state park lodges with considerably more guest rooms, very few approach the size and amenities of the project," the IRS ruled. "Accordingly, we do not find the project comparable to such state park lodges."
All of the 2002 bonds were redeemed last year. The tribe disclosed in October 2005 that the IRS had opened examinations of $74 million of Series 2003 bonds and $50 million of its Series 2004 notes, which were also used to finance facilities at the Hollywood complex. The status of those audits is unclear. From here, the tribe and the agency can attempt to negotiate a settlement with the tax-exempt bond office or appeal the adverse determination with the IRS Office of Appeals.
"I think this proves that [TEB field manager Charles Anderson]'s not racist," former TEB director W. Mark Scott, a partner with Vinson & Elkins LLP, said yesterday, referencing a report submitted to Congress earlier this year that argued TEB's treatment of tribes was manifestly unfair. "Regardless of whether you agree or disagree with the result, this shows that examination function was correct in raising the issues."
Market sources and reports have indicated that there were other problems with the deal beyond the qualification of the tribe's bond-financed activities as essential government functions.
"There were questions as to the amount of private use, the overall management of the facility, and concerns about the amount of fees being paid," one source familiar with the audits said yesterday.
The IRS' preliminary adverse determination on the 2002 bonds, sent more than two years ago, iterated some of those concerns: "The level of issuance costs (approximately 9.62% of the proceeds) that appear to be financed with proceeds of the bonds in this transaction, as well as other information developed concerning certain additional fees paid to transaction participants, may result in the bonds consisting of private-activity bonds," the agency asserted.
The Baltimore Sun has reported that David Cordish, the Baltimore-based developer whose company, Power Plant Entertainment, was paid as a financial adviser in the deal, is receiving millions of dollars in fees every year as part of his contract with the tribe. The Seminoles filed suit in Florida circuit court earlier this year to overturn that contract, arguing that Power Plant would earn more than $2 billion, risk-free, over 10 years for developing the Hard Rock complexes in Hollywood and Tampa.
The Seminole TAMs -- taken with a recent private letter ruling issued by IRS chief counsel for an unidentified tribe -- are also significant because they adopt the line of reasoning the IRS is expected to propose in its new regulations for tribal bonds.
Thomas D. Vander Molen of Dorsey & Whitney LLP in Minneapolis said it was interesting that the IRS is effectively saying "this is already, in their opinion, the proper interpretation of the law."
"You have a poorly worded statute with contradictory legislative history, the IRS on the exam side getting themselves in a lather over these deals, proposed regs that take a conservative position, all with the result that practitioners are running around wondering, 'What the heck are we supposed to do?' " said David Caprera of Kutak Rock LLP in Denver.
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Be Wary Of Bid-Rigging, Players Warn
Posted on Wednesday, December 13, 2006
Source: Bond Buyer
By Matthew Hanson
To help guard against being involved in deals where bids are rigged or yields are manipulated by the parties of a deal, issuers should take several steps, a lawyer and swap provider told members of the muni market yesterday in the final panel of The Bond Buyer's 4th Annual Metro Finance Conference.
It might take several years until we see the results of the investigations now being conducted by the Justice Department and the Securities and Exchange Commission, they said. In the meantime, issuers can educate themselves about how they can avoid being used for an easy buck.
First, issuers should research the backgrounds of the professionals they use, said Peter Shapiro, managing director at Swap Financial Group LLC. They should seek out more than the mandatory three bids and obtain reasonable estimates well ahead of when they take official bids.
And they should be wary of brokers and advisers who also do work for those submitting the bids, he said.
"If the firm that is supposed to be assisting you is also, at the same time, knocking on the doors of people who are seeking your business and seeking the business of them, it's likely to color their judgment," Shapiro said. "This about it this way: how many issuers are there in the county? Tens of thousands. How many major dealers are there? There are really are only 10 or 12."
So, when it comes to thinking about repeat clients, the big banks, insurance companies, and other investment product providers are much more likely to provide future business than a state or local government that is in the market only now and again, he said.
One of the reasons government officials might not have paid such close attention to these issues in the past is that they have little vested interest in how much of their deal is rebated to the federal government, said Bruce Serchuk, partner at Nixon Peabody LLP. But he added that they would likely be expected to take greater care, as regulators sort through the piles of documents they will have collected in the two ongoing investigations.
Dozens of firms have been subpoenaed in the Justice Department's criminal investigation, which seeks information back as far as 1992, and the SEC's parallel civil probe, reaching back to 2000. The two investigations stem from SEC inquiries and Internal Revenue Service audits during the last six years that found problems with bond and investment yields in the muni market as well as the Justice Department's criminal Philadelphia corruption case.
Subpoena recipients so far have include broker-dealers, investment and derivatives brokers and providers, bond insurers, and other insurance companies. On Dec. 15, the Federal Bureau of Investigation raided three firms - California-based CDR Financial Products, the Investment Management Advisory Group Inc., in the suburbs of Philadelphia, and Sound Capital Management Inc., based in Minnesota - to obtain documents for the investigations.
The subpoenas covered a range of derivatives and investment products, including guaranteed investment contracts, or GICs, in which issuers re-invest the proceeds from a bond sale to earn a specified return until they need to use the funds. Justice's investigation revolves around anti-competitive practices such as collusion, bid rigging and price fixing.
The SEC appears to be concerned with securities law violations, including the failure to disclose fees or activities that would jeopardize the tax-exempt status of the bonds.
In its enforcement cases, the IRS was concerned that some GIC providers, often banks and insurers, were overcharging issuers for GICs or other investment products. This would artificially lower or "burn" investment yields below the bond yield. The spread between the investment and bond yields was then passed to the investment provider, rather than rebated to the federal government as required by the tax laws.
The IRS has also expressed concern about firms using credit enhancement and derivatives products to artificially manipulate bond yields.
Since news of the subpoenas first came to light, market participants have voiced their concern over the negative light that the probes could cast on the municipal market. In the investment arena, they echo the problems of the yield-burning scandals of the late 1990s.
The controversy over yield-burning led to a global settlement in 2000 in which17 broker-dealers paid a combined $138.3 million to settle SEC charges in connection with the practice.
The current investigations could prove to carry an even higher price if any wrongdoing is found. Unlike the yield-burning probes, the current controversy involves a criminal investigation. Indeed, a federal grand jury has already been called in New York.
Ralph Giordano, chief of the New York office of the Justice Department's antitrust division, and trial attorney Rebecca Meiklejohn are leading the grand jury investigation. The Bond Buyer first contacted them on Nov. 20, but they declined to comment.
Shapiro pointed to court transcripts from the early 1990s that showed exactly how Stifel, Nicholas & Co. worked to rig two separate GIC deals - one for Sakura Global Capital Inc. and one for AIG. The transcripts describe elaborate schemes in which false bidders were arranged and Sakura and AIG got the contracts. Stifel, in return, received substantial payments from Sakura and AIG.
(c) 2006 The Bond Buyer and SourceMedia, Inc. All rights reserved.
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Enforcement: Court Documents Show What Bid-Rigging Looks Like
Posted on Tuesday, December 19, 2006
Source: Bond Buyer
By Matthew Hanson
So, what exactly does it look like when bids are rigged for a swap or re-investment contract?
Participants from all corners of the municipal market have compared the current Justice Department and Securities and Exchange Commission investigations to past inquiries. Swap Financial Group LLC's Peter Shapiro says two specific cases are prime examples of issuers being taken for a ride.
In 2002, former Stifel, Nicolaus & Co. investment banker Robert Cochran paid $220,000 to settle SEC securities fraud and other civil allegations against him, stemming from undisclosed payments he obtained for Stifel on deals for two Oklahoma-based issuers in the early 1990s.
Cochran previously paid $100,000 in 1999 to settle securities fraud charges filed against him by the SEC involving a refunding deal for the Sisters of St. Mary's Health Care Obligated Group. He was convicted on similar criminal charges, but the Tenth Circuit Court of Appeals later overturned the conviction.
The cases that came out of the deals focused primarily on whether or not Cochran and his associates properly disclosed the complicated payments they received for their companies. The cases were settled, meaning no official wrongdoing was found. But the commission's findings in court transcripts offer a peek into just how participants on a deal can work to rig bids for re-investment contracts, Shapiro, a managing director at Swap Financial, told participants at The Bond Buyer's 4th Annual Metro Finance Conference last week.
When the Oklahoma Turnpike Authority issued $568 million of revenue bonds in 1989, it looked to enter a guaranteed investment contract, giving it a set rate of return until it needed to draw on the proceeds. Stifel was a member of the underwriting syndicate and Pacific Matrix acted as the "finder" for re-investment of the bonds.
Cochran and Pacific conspired to rig the bidding process to Swap Financial Group, according to the commission's findings in a case against Pacific. The two did so by giving AIG a "last look" at its competitors' bids for the contract, documents state.
Cochran arranged to call Pacific Matrix once he learned of the highest submitted bid. He would ask for "Wayne," at which point a certain person at Pacific would take the call without raising the suspicions of others.
This person would then relay the amount that AIG would have to beat to get the contract.
Then, in May 1992, the OTA issued about $608 million of refunding bonds, planning to enter a forward, another kind of re-investment contract. Stifel was one of the book-runners and Pacific acted as "finder." This time, they gave the forward to Sakura Global Capital Inc., according to court documents.
Early on the morning that bids were to be taken, the firms arranged for three firms that were not typically "first-tier players" to submit bids. The firms were assured they would not be awarded the contract if they submitted bids below a certain level, records showed, and Sakura was able to then win the forward relatively uncontested.
While inquiries into these deals resulted only in settlement payments, they still serve as lessons to borrowers who want to avoid being part of such deals.
(c) 2006 The Bond Buyer and SourceMedia, Inc. All rights reserved.
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California Cities Eye Renewable Energy Utilities
Posted on Friday, December 15, 2006
Source: Bond Buyer
By Jackie Cohen
Over two dozen California communities are striving to create publicly financed renewable-energy generation facilities to supplement, if not replace, electricity provided by investor-owned utilities Southern California Edison and its northern neighbor, Pacific Gas & Electric.
With revenue bond issues coming as early as next year, potentially totaling in the billions of dollars, these efforts all piggyback on ongoing amendments to California's Public Utilities Code.
A 2002 amendment sponsored by state Sen. Carole Midgen, D-San Francisco, authorized municipalities to aggregate energy supplies and sell them to customers, a process known as community choice aggregation.
Under CCA, a municipality can create a publicly owned electricity supplier that would rely on the existing power delivery infrastructure and customer service architecture already owned and operated by PG&E and SCE.
The first step in forming a CCA enterprise involves passing ordinances at the local level that create the authority to oversee the new energy utility. So far, only two communities have achieved this: San Francisco and the San Joaquin Valley Joint Powers Authority.
The next step involves local ordinances dictating an implementation plan for a CCA and the entity filing an application with the state's Public Utilities Commission. "So far, no one has filed directly with us," Public Utilities Commission spokesman Tom Hall said.
CCA requires that all customers of the existing utilities receive notification of the option to switch their energy source to the publicly owned provider. Even if customers switch to the alternative provider, the existing utilities PG&E and SCE would still deliver the energy and bill the customers.
A portion of the revenues generated from the monthly billing would go to the CCA provider and that money would ultimately pay for debt service on revenue bonds issued to finance the initial infrastructure investment.
That initial investment may rely on contracts with service providers, which in turn could invest additional money into the project in a public-private partnership to build an electrical utility.
If the electrical utility is to provide renewable energy, the requisite infrastructure is more complicated than building a more traditional power plant.
"Building renewable is like a power plant that's spread out all over the place, and thus more logistically complex. The footprint is at multiple sites, spread across multiple properties -- it's like rolling out a network of solar panels," said Paul Fenn, executive director of Local Power, a renewable energy advocacy group that contributed to drafting San Francisco's CCA implementation plan.
Nearly all of the renewable energy infrastructure proposed for California's CCA efforts thus far have involved solar panels, but San Francisco's Public Utilities Commission is powering its own operations through recycling methane from waste matter. Windmills are another form of renewable energy generation.
While the formal definition of CCA doesn't entail renewable energy sources, the acronym has gotten greener over time, especially with the influence of other state Public Utilities Code amendments, including a requirement that all 20% of California utilities' energy come from alternative sources by 2010.
In August, Gov. Arnold Schwarzenegger signed into law a requirement that all homebuilders make solar energy capabilities available to customers by the beginning of 2011.
Already, utility customers can effectively recoup 50% off the costs of implementing alternative energy delivery in the home and workplace through tax exemptions on the state and federal level, according to Mark Stout, a solar energy consultant with Unlimited Energy.
The firm is helping Fresno and a dozen other municipalities in the middle of the state that officially banded together last month to form the San Joaquin Valley Joint Powers Authority.
While many say the venture has progressed the furthest of any CCA effort in the state, this joint-powers agency, or JPA, is hoping to launch a lower-cost alternative to PG&E providing both renewable and more traditional types of energy.
"We're preparing a permit application to file with the California state energy commission in April, and if the timeline sticks, we'll be in the market for about $600 million in revenue bonds by October 2008, because we've got substantial infrastructure already in place," said David Orth, general manager of the Kings River Conservation District, the largest of the constituents within the San Joaquin Valley JPA.
A potentially similar sized JPA is in a much earlier stage of planning within SCE territory surrounding, but not including, Los Angeles.
Representatives from the 10 cities comprising the Southern California Cities Joint Powers Consortium are still trying to get the topic of CCA onto the meeting agendas of their respective local governments, said the group's executive director, former Culver City Council member Albert Vera.
Marin County and its 11 constituent cities north of San Francisco have been discussing CCA within their respective local governments and conducting feasibility studies on forming a joint-powers authority for providing energy at a lower cost than PG&E.
"We'd like to make a decision in the fall of 2007, and if the decision is favorable then we could go forward in 2008 and hopefully sell revenue bonds that year," said Dawn Wise, sustainability planner at the Marin County Community Development Agency.
The agency has been working with numerous consultants, including the boutique investment banking firm GFP Broker-Dealer Inc., and expects to release another study next summer that will include cost estimates and the target amount of revenue bond issuance.
"Ultimately, we'd like to get to 100% renewable energy but our goal is to get 51% renewable by 2017 because our load in Marin County is around 300 megawatts," Wise said. Marin County wants to keep rates similar to or less than those of PG&E while enabling the CCA to pay for itself, she said.
About $100 million in revenue bonds could come from the eastern suburbs of San Francisco, where the cities of Berkeley, Emeryville, and Oakland are crafting a JPA for providing renewable energy to residents of the area.
"We're working on the business plan, and once it's complete the joint powers authority would go forward," said Neil De Snoo, energy officer for Berkeley. "We'd issue revenue bonds backed by the utility rates, but we wouldn't request the proceeds of the bonds until probably 2011, but there would be a mix of different investment resources coming into this."
De Snoo said the JPA wants to work with PG&E in order to use the privately owned utility's distribution and customer service platform. The publicly owned CCA utility would supply renewable energy, initially all on a contract basis, to go across PG&E's infrastructure.
'The renewable energy services would come from both owned and purchased resources," De Snoo said.
Across the bay, the San Francisco Board of Supervisors will likely hold an educational hearing on CCA implementation in a committee meeting during the third week of January.
"The disappointment is that this didn't get scheduled for this year. This city agrees on the need for renewable energy, and so 2007 is make-it-work time," a spokesperson for San Francisco Supervisor Tom Ammiano said. Ammiano is a sponsor of enacted and pending CCA legislation.
The spokesperson confirmed that after the supervisors approve an implementation plan for CCA, Ammiano would ask for $600 million in revenue bonds to finance the project.
That would pay for renewable energy generation and sourcing, as the CCA program would still rely on PG&E's distribution and customer service platform.
The goal of San Francisco's CCA project is to create enough renewable energy generation to produce 360 megawatts of power, in a generation facility covered in solar panels.
In addition to bond financing, San Francisco is encouraging additional investment from the renewable energy supplier that would be chosen by the city's Public Utilities Commission.
(c) 2006 The Bond Buyer and SourceMedia, Inc. All rights reserved.
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Enforcement in Limelight
Posted on Tuesday, December 26, 2006
Source: Bond Buyer
By Alison L. McConnell
With the Justice Department conducting the widest-ever criminal investigation of alleged illegal behavior in the municipal bond market, enforcement issues are expected to occupy center stage all year long.
At the same time, after significant transition in 2006, the Internal Revenue Service's tax-exempt bond office - the front line of federal enforcement against deals that line the pockets of underhanded market players - faces a second round of upheaval in the impending departure of a longtime senior staffer who has been a force to be reckoned with for years. Filling his shoes, and other key vacancies, could prove to be TEB's greatest challenge in 2007, according to sources.
The tax-exempt bond office, which closed 495 audits and 60 voluntary closing agreements this fiscal year, examines issues of municipal bonds for problems associated with compliance with federal tax code rules. It employs 67 people, 47 of whom are field agents.
Derek Knight and Karen Skinder, two of TEB's five group managers, are thought to be top candidates for the position of field operations manager, currently held by Charles Anderson, who has been with the IRS for more than three decades and has served in the role since TEB was formed six years ago. Anderson is scheduled to retire Jan. 4 but his replacement is not likely to be named for some time.
Market sources indicated that the task of replacing him is critical for TEB director Clifford Gannett, who himself was part of the personnel transition experienced by the office this year. Gannett took over as acting director when W. Mark Scott left the IRS late in 2005. A 23-year agency veteran, Gannett had previously headed up TEB's office of outreach, planning, and review - now the office of compliance and program management, or CPM - and in June was formally promoted to director.
Steven A. Chamberlin is currently acting director of CPM, and the IRS is conducting internal searches to fill that position and Anderson's on a permanent basis.
Market participants say the selection of strong managers for field operations and CPM is of major importance, particularly since the TEB office is relatively small, with a correspondingly modest budget.
"TEB, since its inception, has relied upon the skill and depth of its management team to compensate for what it lacked in resources," said Jeremy A. Spector, a partner with Blank Rome LLP in Philadelphia. "To maintain its hard-earned momentum, TEB would be best served by addressing its personnel issues on a priority basis. [The office] is fortunate to have talented candidates within its ranks. Delays in the selection process could eventually hamper operations."
While the actual processing of cases should not be affected significantly in 2007, "the transition is important from the perspective of setting the tone or direction of the office moving forward," said former director Scott, now a partner with Vinson & Elkins LLP here.
National Association of Bond Lawyers president Carol L. Lew, a partner with Stradling Yocca Carlson Rauth in Newport Beach, Calif., said attorneys have the "utmost confidence" in Gannett's and his staff's ability to find and retain good people for positions at TEB.
"Although we will miss Charlie and wish him the best in his retirement, we look forward to working with Cliff and Charlie's successor on efforts that further our mutual mission of encouraging compliance through education," Lew said.
The second round of staff transition will come in 2007 as TEB continues to ramp up its enforcement efforts against "bad players" in the market. Anderson, Chamberlin, Gannett, and tax law specialist Michael J. Muratore asserted at a press briefing last month that TEB has made significant inroads in its audits of abusive transactions and the professionals behind them.
In addition to the audit work, agency officials are shifting their focus to the professionals behind such deals with an eye to assessing Section 6700 penalties. That section of the tax code allows the IRS to apply monetary penalties to individuals or firms that participate in abusive transactions.
Market participants may see relatively new twists in 2007 in terms of tax problems with deals, according to Anderson. He has repeatedly stated that arbitrage schemes have moved from the investment-yield side of bond issues, where parties historically overpriced U.S. Treasuries and other securities purchased with bond proceeds for investment escrows to keep the yields down on those escrows.
Tax code regulations stipulate that earnings on investments exceeding the underlying bonds' yield by a certain percentage must be rebated to the federal government. By inflating prices, firms were able to artificially lower, or "burn," investment yields down within a permissible range, while keeping the profits.
MORE SCHEMES
Now the IRS is discovering more and more schemes on the bond yield side, namely via pricing irregularities with swaps and other hedges, credit enhancements and bond insurance, and issue price.
The IRS is also concerned about bond yield manipulation via "flipping," in which an underwriter sells bonds to an institutional investor who sells them almost immediately to another investor, potentially making it difficult to calculate bonds' issue price and therefore their yield.
Flipping may turn out to be "a big issue, and have already sent out several adverse letters on this," Anderson said.
Gannett said late last month the IRS is indeed seeing increased sophistication on the part of those who craft, promote, and profit from abusive transactions. The common theme? Certain market players are devising new ways to mask excess arbitrage earnings through the manipulation of bond yields and divert those profits to deal participants in post-issuance or secondary transactions.
In one such case, IRS officials said in May that they had unearthed a "systematic kickback scheme" involving several major credit enhancers and brokers of guaranteed investment contracts, or GICs.
The scheme involved qualified guarantees for unloaned proceeds from so-called lease-to-own bond deals. Officials found evidence of wire transfers between deal participants that they believe represented diversions of arbitrage that should have been rebated to the federal government.
Those deal participants are thought to include Beverly Hills, Calif.-based CDR Financial Products, a boutique financial products firm that provides a range of swap advisory services to municipal clients, and French bank Soci?t? G?n?rale. CDR, then Chambers Dunhill Rubin & Co., served as structuring agent, GIC broker, and in other roles in about 20 lease-to-own transactions in the late 1990s through 2005. SocGen provided credit enhancements as liquidity provider, forward agreement purchaser, and investment agreement provider in the deals.
CDR was one of three firms raided on Nov. 15 by Federal Bureau of Investigation and Justice Department officials as part of the department's criminal antitrust investigation. A spokesman for the firm declined to comment, but CDR has argued that the lease-to-own program, operated in part by Freddie Mac, was a valuable and viable effort to help low-income residents get into housing.
"CDR was paid fees by credit enhancers for advising them with respect to the risks of entering into forward commitments to purchase 30-year mortgages at a preset prices and interest rate," the firm told The Bond Buyer in June. "CDR is not aware of any scheme to pay any amounts not earned for services rendered in connection with any lease-to-own transaction."
The Justice Department investigation, which could cover some of the alleged problems found in the lease-to-own deals, is being conducted by department officials, including U.S. attorneys, the IRS' criminal investigation division, and the FBI. The probe is purportedly focused on price fixing, bid-rigging, and other anti-competitive practices in the muni market in connection with GICs, other investment vehicles, and derivatives transactions entered into the past 14 years.
Roughly two-dozen firms are thought to have been subpoenaed by a federal grand jury. The probe grew out of a criminal referral made by the TEB office several years ago, as well as Securities and Exchange Commission inquiries.
The SEC is conducting a parallel civil investigation into potential securities fraud issues related to the alleged anticompetitive practices and has subpoenaed at least seven firms for similar records dating back to 2000.
A FEW BAD ACTORS
To comply with subpoenas, firms had until Dec. 18 to submit documentation of every investment contract or derivative transaction entered into in connection with munis during the two time periods. Truckloads of records must now be examined by Justice and SEC officials, and the federal grand jury's proceedings could take years, according to sources.
"The investigations are not expected to be swift. In the meantime, the industry is being unfairly tarred by the actions of relatively few bad actors," said Blank Rome's Spector, who serves as chair of the American Bar Association tax-exempt financing committee's subcommittee on enforcement.
NABL's Lew said it is difficult to project the timing of a resolution since little public information about the proceedings is available.
"The significance of the potential charges will likely be considered by most counsel in advising issuers as to the investment of bond proceeds," she said. "This type of potential misconduct occurs in various parts of the economy. It is unfortunate that it has impacted the municipal finance community. We believe that effective enforcement efforts will resolve the issues."
At this point, it is unclear how industry participants will respond to the investigations and their consequences, but in the meantime issuers should make sure they have adequate internal controls in place, according to Vinson & Elkins's Scott.
NABL will hold a teleconference in the first six weeks of the new year to discuss the investigations and help bond counsel develop best practices for the investment of bond proceeds and related issues. Panelists will include lawyers and financial advisory professionals, according to Lew.
The NABL president noted that one of the biggest challenges for TEB this year may be effectively utilizing resources so clear tax abuses are addressed, while minimizing the time and expense incurred by the vast majority of issuers who make their best efforts at tax compliance.
"This is not a new challenge, but it is an important ongoing one as it affects the health of the tax regulatory system," Lew said.
"TEB is actively continuing its work with other [tax-exempt and government entities division] offices in the further development of our data analysis tools and resources," Chamberlin said. "I am encouraged with the progress we've made thus far and believe that the possibilities for enhancement of our case selection process will build upon our compliance program's past successes."
In addition to pursuing "bad actors" in the market, IRS officials in 2007 will continue pursuing several audit initiatives and procedural updates.
As part of TEB's 501(c)(3) initiative, launched this summer, agents are gearing up to open correspondence audits of several hundred bond issues. Those audits will primarily target nonprofit hospitals and will collect compliance information, allowing TEB to analyze specific problem areas, officials have said. The project is mainly focused on post-issuance compliance issues such as private business use, research agreements, management contracts, and lease arrangements.
SWAPS INITIATIVE
The office's so-called swaps initiative was also launched this summer. That inquiry involves agents analyzing hedges of interest rate risk for problems associated with the qualification of hedges, the treatment of off-market components, the valuation of termination fees, and the proper accounting treatment of hedges - all for swaps, caps, and other derivatives transactions entered into in conjunction with bond deals completed at least five years ago.
One of the most significant problems uncovered by the exams thus far, according to officials, is some issuers' failure to rebate arbitrage in compliance with tax code rules.
Beyond those projects, next year the TEB office will likely wrap up its ongoing solid-waste, single-family, and multifamily housing audit initiatives, according to agency officials.
The office is also systematically updating its Internal Revenue Manual to provide more transparency about its procedures. In September, it released an updated version of the revenue procedure used by municipal issuers who want to challenge agency determinations that bonds are in violation of tax laws. Issuers can file administrative appeals of such determinations with the IRS Office of Appeals, which is separate from TEB.
The new revenue procedure reflects organizational changes and stipulates that when cases do not get resolved in appeals, they cannot revert back to TEB for a new round of settlement negotiations. It also codifies the relatively new practice of not offering so-called Section 6700 passes, which previously brought transaction parties into settlements by protecting them from other penalties.
TEB is also developing a compliance regime to replace the voluntary closing agreement program, or VCAP. Issuers can utilize the program when they discover problems with their bonds, before the deals are audited by the IRS. The new voluntary compliance regime will likely include defined settlement terms for specific types of violations, expediting the process for issuers with fairly straightforward tax problems, according to officials.
Alternative dispute resolution mechanisms that encourage voluntary compliance are important to the effectiveness of tax system, according to NABL's Lew.
"We are pleased with the openness of TEB to explore alternatives in this area," she said, adding that it is critical the office alerts the public finance community about its general concerns so proactive measures can be taken to guard against noncompliance.
"We welcome the efforts of Cliff Gannett and his staff at making efforts to communicate areas of concern," Lew said.
Spector said an intermediate sanctions regime could stimulate requests for closing agreements. "I would like to see TEB increase its staffing in CPM to accommodate a greater industry attention to voluntary compliance," he said.
One industry source who did not wish to be identified pointed out that the audit side of enforcement proceedings remains much more adversarial than the voluntary compliance side.
"There's a belief among many audited parties and their counsel that the system is sorely lacking in balance - in other words, it's just not fair," the individual noted. "First, of course, is the frequently voiced view that because there is no practical access to judicial oversight, the service remains free to assert more or less whatever position it deems appropriate. While its position certainly isn't always wrong, when it is, or is strongly believed to be, there's often no practical recourse."
"We have seen several instances where we effectively have law by audit position. The auditors assert a position, and that then becomes the benchmark for the practice," the source said. "Even if bond counsel were prepared to render an unqualified opinion - if they legitimately conclude that a court would not agree with the IRS' asserted position - the obligation to disclose the issue pretty much ensures that the deal won't get done."
While private-letter rulings can be sought in those cases, the process is both time-consuming and expensive, and issuers frequently abandon deals they should be able to do, the individual continued. "In other words, the audit branch is making law without the pesky requirement that the rule be vetted by [IRS] chief counsel and Treasury."
THE TRIBAL SECTOR
The tribal bond sector has been a prime example of such controversies for years, and that was no different in 2006. IRS chief counsel issued a handful of rulings for Indian tribes that had issued tax-exempt debt or borrowed bond proceeds from municipalities. The rulings were, on the whole, interpreted by market participants as negative or restrictive, drawing vociferous reactions.
Currently, the tax code treats tribes as states for purposes of tax-exempt bond issuance if the bonds are used to fund activities that are considered "essential government functions." The proper interpretation of those three words, however, has been hotly contested by tribes who want greater access to debt financing to offset minimal property tax bases and federal officials who say Congress never wanted commercial or industrial ventures built with bonds.
"One of the IRS' greatest challenges is working with practitioners who are representing the issuers but are also defending their own opinions," another market source said. "The tribal bond controversy is exemplary for its large-scale effort to defeat the efforts of Treasury and the IRS to enforce the law. The resources involved and consumed in that controversy were inordinate. So much more could have been accomplished by the government and the industry had it not been so distracted."
Another source concurred, saying: "It didn't have to get this ugly. A couple of attorneys in the IRS and in the practitioner community are responsible for spinning this issue out of control. And, like usual, Indian Country paid the price."
The solid-waste sector has also seen its fair share of controversy over the years. In 2006, the IRS' Anderson announced that TEB officials were working closely with the agency's large and mid-size business division to penalize conduit borrowers who used solid-waste bonds for allegedly unqualified projects.
Tax code regulations allow municipal issuers and conduit borrowers to use solid-waste bonds to finance facilities that process material with no market value at the place it is processed and at the time bonds are issued. Tax problems cited by the IRS in the sector are quite varied, but often revolve around the waste material's alleged value.
Market participants' lack of recourse is particularly apparent in that area, where the IRS "doubles up," asserting a conduit borrower's loss of interest deductibility under Section 150 of the tax code and declaring bonds taxable, penalizing investors, according to a market participant familiar with solid-waste deals and enforcement actions.
That "double dip" ratchets up the pressure on the borrower to settle without giving the issue a fair shake, since issuers cannot take the IRS to court to challenge agency determinations, the source said.
Anderson says those complaints are not realistic. "We still are willing to suspend taxing bondholders if conduit borrowers want to take the 150(b) issue to court," he said. "This entirely eliminates the doubling-up concern and pressure to settle. I think that the lack of 150(b) cases in tax court indicates that our determinations have been on the mark."
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November 2006
Tips For TIFs: Development Experts Chime In on Trend
Posted on Wednesday, November 08, 2006
By Tedra Desue
Officials Should Know What Buyers Look for in TIF Deals, Experts Say
Posted on Wednesday, November 08, 2006
By Tedra DeSue
IRS' Charles Anderson to Retire From TEB Office Jan. 4
Posted on Thursday, November 09, 2006
By Alison L. Mcconnell
Justice, SEC Probe Muni Derivatives - Massive Investigation Includes Investments
Posted on Tuesday, November 21, 2006
By Lynn Hume and Alison L. McConnell
Market Shocked at Justice's Reach - Probes May Revisit Yield-Burning Deals
Posted on Wednesday, November 22, 2006
By Lynn Hume and Alison L. McConnell
Tips For TIFs: Development Experts Chime In on Trend
Posted on Wednesday, November 08, 2006
Source: Bond Buyer
By Tedra Desue
While tax increment finance districts continue to grow in popularity as a redevelopment tool, there are some key issues government officials should keep in mind when setting them up, according to panelists at yesterday's Tax Increment Financing Policy and Practice Symposium sponsored by the Council of Development Finance Agencies.
Panelists from almost every spectrum of the TIF creation process gave their thoughts, highlighting the good and the bad.
TIFs, also called tax allocation districts, or TADs, are seen as a way to rid communities of blight and to spur economic development.
Formation of TIF districts allows cities and counties to freeze existing property values within a district's boundaries. As property in the district is developed, the additional taxes paid on the incremental increase in value can be reinvested in the district or used to back debt. In most instances, other taxing entities, such as school districts, have to agree to give up tax dollars from that incremental increase so that they can go to the development district.
One point most market players and government officials agreed on was the need for developers who have deep pockets in addition to a proven track record of success.
Laura Radcliff, a managing director with A.G. Edwards & Sons, said it was crucial that developers have access to financial resources for cases in which bond proceeds were insufficient to cover the costs.
"It's important that they show they have the capability to do the project," she said. "You have a reliable market analysis, and the developer should be able to show that if additional funds are needed, they have access to more funds."
Andrew Frank, the executive vice president of the Baltimore Development Corp., told the group about his organization's work to build Clipper Mill on an abandoned site that was used primarily for manufacturing buildings. Today it houses office, retail, and residential space.
Frank said one priority was making sure the city was practical in determining how much it should contribute to the project, as well as how much the developer would have to kick in.
"The goal is to minimize the city's involvement and maximize the city's returns," Frank said.
That goal can sometimes tie the hands or negatively affect the developer, said Tim Pula, senior development director of Struever Bros., Eccles & Rouse. He was developer for the Clipper Mill project and he recalled the difficulties he found during inspections.
"The inspector is trying to protect the city's interest, and sometimes the process could take weeks," Pula said. "In the meantime, we've got construction crews ready to start."
Panelists said that while some obstacles are inevitable, there are steps that can be taken early on in the process that could stymie any future problems.
"There should be an agreement on a certain set of assumptions between the city and the developer, and that drives the rest of the process," Frank said.
Those assumptions will help determine what the returns will be for the city and the developer. (c) 2006 The Bond Buyer and SourceMedia, Inc. All rights reserved.
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Officials Should Know What Buyers Look for in TIF Deals, Experts Say
Posted on Wednesday, November 08, 2006
Source: Bond Buyer
By Tedra DeSue
Local government officials should be aware that investors consider various factors when looking at bonds sold by tax increment finance districts.
That was one of the topics discussed yesterday at the Tax Increment Financing Policy and Practice Symposium sponsored by the Council of Development Finance Agencies.
Richard Stein, the director of credit research for OppenheimerFunds Inc., noted that there are some inherent differences in the types of TIF projects that are created. Some can be strictly residential, while others can be mixed-use, with a blend of residential, commercial, and office space.
For the most part, mixed-use projects or those that are largely commercial tend to be viewed as riskier because they depend on the developer inking contracts with retailers that will cause the incremental taxes raised through the TIF to be sufficient enough to pay off the bonds.
Formation of TIF districts allows cities and counties to freeze existing property values within a district's boundaries. As property in the district is developed, the additional taxes paid on the incremental increase in value can be reinvested in the district or used to back debt. In most instances, other taxing entities, such as school districts, have to agree to give up tax dollars from that incremental increase so that they can go to the development district.
The districts are also referred to as tax allocation districts, or TADs.
Stein also noted that it is important that officials consider the long-term plans of the major retailers locating in the district. He advised municipalities avoid inking leases for short durations, such as 10 years.
"You don't know what will happen at the end of 10 years - sometimes retailers choose bad locations for their businesses and if they are your only tenant, that likely will be a problem," Stein said. "It's always important to have diversification, including mom and pop stores, and a large retailer."
Jonathan Chirunga, a research analyst for T. Rowe Price Associates, agreed. He added that when his firm evaluates which TIF bonds would be worth investing in, it often looks at the developer and its financial strength.
"It boils down to how we like the deal," Chirunga said. "We're willing to be sizable players if they are good bonds."
Given the complexities of TIF deals, investors say they also look at exactly who the players putting them together are. And while feasibility studies that the team presents are helpful, panelists were split about exactly how much they should be used in determining a deal's viability.
Stein joked that he had never seen a feasibility study that basically said the deal was infeasible.
On that same note, panelists said there was always something that could be gleaned from the documents. Mark Hughes, a senior vice president with First Albany Capital, said such documents were important.
"Giving more disclosure about what's going on in that community to give to investors is very important because it points out what the strengths are of that community, and what the weaknesses are as well," Hughes said.
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IRS' Charles Anderson to Retire From TEB Office Jan. 4
Posted on Thursday, November 09, 2006
Source: Bond Buyer
By Alison L. Mcconnell
Charles Anderson, field manager of the Internal Revenue Service's tax-exempt bond office, will retire Jan. 4.
After 33 years with the agency, Anderson recently decided to move up his anticipated departure date by a few months because it is "time to go," he said in an interview yesterday. Anderson has headed up field operations for the TEB office since its inception in early 2000.
As part of the IRS' tax-exempt and government entities division, TEB has grown from a fledgling program six years ago to a full-bore enforcement section that aggressively pursues abusive municipal bond deals. Its evolution has met mixed reactions from market participants who both applaud its efforts to penalize "bad actors" and question the tough, sometimes unyielding stance it takes in audit negotiations.
Current TEB director Clifford Gannett, former director W. Mark Scott, and Anderson "were there at the beginning together, and while we disagreed a lot we were always brutally honest with each other," Anderson said.
He noted that, early on, they often did not get much internal support from upper management on enforcement procedures. But when former IRS commissioner Charles Rossotti departed and the pendulum swung back under current commissioner Mark W. Everson, TEB found itself "ahead of the curve," Anderson recalled.
"I remember Mark and I having discussions on how to focus on enforcement instead of some of the fluff that Rossotti was shoving down everyone's throats. It didn't make us too popular in TE/GE," he said. "Cliff did a great job integrating [the voluntary closing agreement program] into the whole enforcement structure so we were able to keep focused on that."
Anderson said he would probably work part-time after retiring from the IRS and currently has some options to consider.
"If I decide to do any consulting, there will certainly be a list of people that I won't be associated with, I can tell you that," he said. "I just don't know how much that I will want to take on. I will be building a house in Pennsylvania in 2008 and will certainly do some charity and pro bono work in my local community, if any of my experience in bonds or exempt organizations is useful there."
He predicted that buy-side risk analysis and pre- and post-audit due diligence will be critical issues for the municipal market in the coming years. "People should run like the wind when they see certain firms as special tax counsel," he warned.
Anderson also said there is a "sharp cut-off" in the quality of various firms doing arbitrage rebate work today.
"Cliff is designing a very aggressive approach to arbitrage rebate [and] I think that this area of practice will become especially important to issuers," he said. "Cliff is a real rebate guy and he is now getting his horses together. I think that he will surprise people with his arbitrage team."
Anderson had high praise for his current and former colleagues at TEB.
"I have the utmost respect for Mark, Cliff, and my group managers: Karen Skinder, Derek Knight, Allyson Dodd, Tanya Kryah, and Carl Scott," he said. He added that Gannett would be well-served to consider any of those managers for his position or the vacant spot at the head of TEB's office of compliance and program management, which Gannett used to run.
"The agents were loyal. I hope they realize that I tried to watch their backs for them," Anderson said. "I think that we actually did something and affected practices rather than just talking about it."
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Justice, SEC Probe Muni Derivatives - Massive Investigation Includes Investments
Posted 11/21/06
By Lynn Hume and Alison L. McConnell
In the largest and most sweeping federal investigations ever conducted of the municipal market, the Justice Department and Securities and Exchange Commission have each asked dozens of firms for information about virtually every investment product or derivative they have brokered, provided, or otherwise been involved with in connection with municipal bond transactions over the past six to 14 years.
“This is massive,” one market participant familiar with the investigations said yesterday.
The Bond Buyer has learned that the parallel criminal and civil investigations go far beyond GICs and may cover thousands of investment products and derivatives entered into in connection with muni bond transactions that could total hundreds of billions of dollars.
Only a portion of that universe is expected to be tied to civil or criminal allegations, however, as the Internal Revenue Service has reached settlements or taken enforcement action with regard to $15 billion to $20 billion of muni bond issues in recent years over investment products or derivatives that contributed to tax law violations, sources said.
The probes cover a wide range of investment and derivatives brokers and providers, including insurance companies, securities firms, banks, derivatives firms, financial advisers, and investment advisers.
The Justice Department’s antitrust division, which is working with the IRS’ criminal investigation division and the Federal Bureau of Investigation on the criminal probe, is focusing on anti-competitive behavior such as collusion between firms to get business, rig bids, and fix prices with regard to transactions that date back through 1992, sources said.
The Justice subpoenas, served Wednesday to at least two dozen firms, asked for documents, e-mails, tapes or notes of phone conversations, and other information regarding “contracts involving the investment or reinvestment of the proceeds of tax-exempt bond issues and qualified zone academy bonds [as well as] related transactions involving the management or transferal of the interest rate risk associated with those bonds, including but not limited to guaranteed investment contracts; forward supply, purchase, or delivery agreements; repurchase agreements; swaps; options; and swaptions.”
The subpoenas also requested corporate organizational charts, telephone directories, and lists of all individuals involved with GICs and derivatives, in addition to all documents associated with “relevant municipal contracts awarded or intended to be awarded pursuant to competitive bidding” — including invitations to bid; solicitations, notices, or requests for quotations or proposals issued to any provider; actual or proposed responses; and amounts and prices bid. The documents are to be submitted by Dec. 18, according to the subpoenas.
“The industry tends to be quite intertwined and interconnected,” said Willis Ritter, a partner at Ungaretti & Harris LLP here. “Virtually all the major houses are involved in selling [GICs], so if you think you’ve found something about one, you suspect you’re going to find it about all of them. I think the government believes the whole industry moves like a herd. That would explain why this covers so many people.”
Ritter added that swaps and other derivative products were a logical inclusion in the Justice and SEC inquiries.
“A swap is a means of affecting the interest rate on bonds just as an investment agreement affects the rate on the investment. It’s the other side of the same coin,” he said. “Plus, the people involved in the swap industry are very much same people that are involved in GICs because it involves the same types of analysis, hedging, skills, and capital requirements.”
The SEC is conducting a parallel civil investigation into transactions dating back through 2000. The commission is looking at whether firms disclosed that bidding practices for GICs and other investment products were competitive when they were not, made or received hidden fees, payments, or kickbacks, or failed to disclose other key information to issuers or investors, according to sources.
The SEC subpoenas were similar to the Justice Department’s, requesting information regarding “guaranteed investment contracts, repurchase agreements, flexible repurchase agreements, collateralized certificates of deposit, forward delivery agreements, forward supply agreements, put agreements, interest rate swaps, and basis swaps.”
Sources familiar with the both federal investigations said subpoenas sent to other firms appeared to contain the same language. Some only requested documents while others required appearances before a federal grand jury, they said.
While swaps are deemed to be derivatives contracts and not securities and therefore cannot be regulated by the SEC, the commission’s Rule 10b-5 gives it broad latitude to investigate any alleged fraud in connection with the purchase or sale of a security. As a result, swaps and other derivatives entered into by municipal issuers in connection with underlying bond issues may fall with the SEC’s enforcement realm.
The IRS’ tax-exempt bond office, which in 2004 referred a mass of investigatory findings to the Justice Department, has been looking at issues related to derivatives and investments of bond proceeds in a variety of audits for at least three years. According to sources, Justice has now picked up the prosecution using the 1890 Sherman Act, which prohibits any agreement among competitors to fix prices, rig bids, or engage in other anti-competitive activity.
Sources said yesterday that Justice, which under antitrust laws would have to prove its case beyond a reasonable doubt to get convictions, may be pursuing certain firms with an eye to charging them with continuing acts of conspiracy based on criminal activities that could date back to 1992 but involve payments made or collected more recently. Antitrust statutes of limitation expire five years after the date an alleged conspiracy is somehow dissolved, according to sources.
“The fact that they may be out of time with regard to statutes isn’t determinative of how far back they can look,” one attorney said.
And the sweepingly broad case may have taken years to develop because federal officials did not want to limit themselves in their hunt for patterns of criminal activity over time, another noted.
Yet the scope of the Justice and SEC probes is so wide that cases could take months or years to unfold, some have said.
“One cannot help but note that when you throw this wide a blanket over an entire industry, it begins to look very much like a fishing expedition rather than [something] specifically targeted toward any particular institution or practice,” Ritter said yesterday.
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Market Shocked at Justice's Reach - Probes May Revisit Yield-Burning Deals
Posted 11/22/06
By Lynn Hume and Alison L. McConnell
Municipal market participants yesterday were surprised at the breadth of the Justice Department’s investigation of anticompetitive practices in the investment and derivatives areas of the market, with some suggesting the probe may reach back to some of the deals involved in the Securities and Exchange Commission’s global yield-burning settlement with firms six years ago.
Their comments came after The Bond Buyer reported Monday that the Justice Department and the SEC had subpoenaed dozens of firms for information about virtually every investment product or derivative they have brokered, provided, or otherwise been involved with in connection with municipal bond transactions over the past six to 14 years.
In separate sets of subpoenas sent to broker-dealers, banks, insurance companies, investment advisers, and financial advisers, the Justice Department asked for information going back through 1992, and the SEC asked for data going back through 2000, on guaranteed investment contracts, forward supply and purchase agreements, repurchase agreements, swaps, options, and swaptions.
“With the subpoenas seeking information going back to 1992, Justice may be looking at bid-rigging in the deals involved in the yield-burning scandal,” said one long-time market participant who did not want to be identified.
“It is a possibility,” said one source close to the investigations. The source said the Internal Revenue Service has subsequently audited some of the deals that were involved in the global yield-burning settlement for issues that were not covered by the settlement, such as the under-pricing of forward agreements.
In the global yield-burning agreement, the largest settlement ever reached in the muni market, 17 broker-dealers agreed to pay more than $138.3 million to globally resolve federal yield-burning allegations with the SEC and to compensate issuers for losses in connection with 3,603 advance refundings done for hundreds of state and local governments between 1990 and 1994.
The SEC claimed the firms overcharged issuers for open-market Treasury securities for refunding escrows and that the markups reduced or burned the investment yield so that it was below the bond yield and did not generate illegal arbitrage profits. However, in some of the cases, yield burning occurred because issuers underpaid for forward-float agreements, sources said yesterday. The settlement did not cover forwards, bid rigging, or collusion among firms, which could be fair game for the Justice Department in the current probe, the sources said.
Criminal antitrust statutes of limitations run five years from the last act in furtherance of a conspiracy, and the federal government’s position in such cases is that a “last act” can be the last payment made on an allegedly fixed contract, an antitrust lawyer said. If final payments occurred within the last five years, the department could bring a slew of past transactions into the picture in a trial, he said.
The Justice Department and the SEC are believed to be investigating, among other things, whether certain investment brokers and providers have developed secret relationships with broker-dealers and have been steering muni business to the dealer firms in return for fees for specific transactions or monthly retainer payments.
One issuer who did not want to be identified said yesterday that years ago he was involved in an escrow restructuring that involved a forward agreement and later found out that the dealer-financial adviser in the deal had served as a “front” for an investment adviser that had put the whole deal together and had manipulated the escrow to ensure the forward would be worth millions of dollars for the broker-dealer firm that provided it.
But several sources questioned the need for the department to go back to 1992.
“I think they’re asking for too much information, it’s too broad, and it’s negatively impacting people that have done nothing wrong,” said W. Mark Scott, a partner at Vinson & Elkins LLP here who formerly was director of the IRS tax-exempt bond office. “They’ve sent out summonses or subpoenas to parties that are innocent that ask for a mountain of information without considering the costs and ramifications on these parties. What are they going to do with a hundred truckfuls of information? Clearly they’re searching for the smoking gun, but with respect to the firms that they don’t seem to have any concerns about it seems like they could have been narrower in the requests.”
“They are going to have to have a warehouse to hold this stuff and semis to move it,” said Frank Hoadley, Wisconsin’s capital finance director.
“What scares me about this is the enormous resources it is going to take to respond to the subpoenas and information requests and the federal resources that are going to be needed to analyze this stuff. The whole market’s going to pay,” Hoadley said. “I hope that they can quickly become surgical about this.”
But Hoadley said he has no doubt the Justice Department will uncover some wrongdoing. “Are they going to find fraud? Of course they’re going to find fraud. I’m certain it’s there,” he said.
Patrick Born, the chief financial officer for Minneapolis who chairs the Government Finance Officers Association’s Governmental debt management committee, said the Justice and SEC probes should make issuers more careful about the transparency of muni and muni-related transactions, as well as the quality of transaction participants.
“Based on the size and scope of this investigation as reported, issuers should be very concerned about potential abuses taking place and should be even more sure than they were before about the quality of professional representatives they are using,” Born said.
“We need to carefully examine whether there is appropriate transparency in the way the municipal bond business is being done in these areas,” he said. “The municipal market is very important to state and local governments and with this investigation it may be tainted. It’s important that everybody who benefits by and supports this market take steps to improve transparency in every transaction — not just the pricing of bonds, but the investment of bond proceeds, derivatives, and related financial products.”
Both Micah Green, co-chief executive officer of the Securities Industry and Financial Markets Association, and Carol Lew, president of the National Association of Bond Lawyers, stressed that their organizations support the investigation and punishment of wrongdoing in the municipal market.
“This has just unfolded, but if the allegations are correct we are dismayed about the behavior of certain market participants,” said Lew, a partner with Stradling Yocca Carlson Rauth in Newport Beach, Calif.
“NABL does not tolerate corruption and unethical behavior in the marketplace. This type of behavior unfortunately happens in different parts of the economy, and the government has a host of different tools it can use” to go after abuses, she said.
To fulfill its mission of improving the integrity of the municipal bond market, NABL is actively planning educational programs for its members to assist them in dealing with “the nuts and bolts of best practices” in the context of the Justice and SEC investigations, Lew said.
The association is also attempting to proactively work with federal officials to find simple administrative solutions to problems within the market, such as a simplification of the arbitrage regulations, which is already the subject of a NABL comment project, she added.
“If the regulators have a concern there is something out there, they ought to investigate it,” Green said. “We support the full enforcement of the laws and regulations. The best way to avoid changes that would make the laws and regulations more onerous is to enforce the ones on the books.”
But Green said he does not think the Justice and SEC probes should taint the market. “I don’t think we should consider there’s a cloud [over the muni market] because there’s an investigation,” he said. “We shouldn’t presume there’s wrongdoing or the outcome of the investigations.”
“If it gets out the bad guys, that’s a public service,” said Peter Shapiro, managing director of Swap Financial Group. “If it scares people away from the products and if people start to view this as a rigged market, that’s bad, because the vast majority of the market is not rigged.”
“Beyond the publicity, if there really is a problem, it’s unfortunate for the municipal business,” said Herman Charbonneau, senior vice president and manager for public finance for Roosevelt & Cross Inc. “We really don’t need to have the image that we’re consistently reaching into new areas of the marketplace to generate transactions that are questionable or profits that are not justified.”
Charbonneau, whose firm has not received subpoenas from the Justice Department or the SEC regarding the ongoing investigations, said he worries that problems being probed stem from the growing use of intermediary firms, which dealers increasingly turn to for help in arranging the details of bond transactions. Since the industry came under scrutiny for yield burning in the late 1990s, these intermediaries have become one way to make sure all the additional due diligence is completed, he said.
The intermediaries have generally been efficient and satisfied all the requirements set out by bond counsel, Charbonneau said, adding that his firm has in the past worked with Sound Capital Management Inc., one of the GIC brokers that was raided by the Federal Bureau of Investigation last week.
“You go out even if you’ve got a small issue — say you’ve got a $12 million issue — you need open markets, you need a GIC, you need a float contract or something like that for refunding,” he said.
“They have the industry contacts and they can scare up interest even in something very marginal from the standpoint of a substantial government dealer,” Charbonneau said. “I assume that perhaps some of the problem is how they scare up some of that interest.”
He added that the current investigations highlight how bond counsel firms might have to go to greater lengths to ensure that the process of securing GICs, swaps, and other extras is legitimate.
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October 2006
Derivatives: Panelists at TBMA Conference Preach Caution When It Comes to Swaps
Posted on Thursday, October 12, 2006
By Matthew Hanson
New PILOT Regulations Under Fire
Posted on Friday, October 20, 2006
By Alison L. Mcconnell
How the Boy Scouts of America Helped to Save Municipal Bonds
Posted on Monday, October 23, 2006
By Craig T. Ferris
The Tax Reform Act, 20 Years Later
Posted on Monday, October 23, 2006
By Craig T. Ferris
A Vague Future For Tax Reform
Posted on Tuesday, October 24, 2006
By Alison L. McConnell
Derivatives: Panelists at TBMA Conference Preach Caution When It Comes to Swaps
Posted on Thursday, October 12, 2006
Source: Bond Buyer
By Matthew Hanson
Credit analysts from the nation's major rating agencies and bond insurers explained their take on municipal derivatives yesterday, pointing out best practices to ensure that issuers know what they are getting into when they sign up for swaps and hedges.
Playing the role of cautioners among a slate of other panels extolling the benefits of derivatives at The Bond Market Association's muni derivatives conference, the analysts explained how they evaluate the quality of such contracts.
"Derivatives are like prescription drugs," said managing director David Litvack of Fitch Ratings, explaining what he called a derivatives warning label. "They can be beneficial when used appropriately ... but they may be habit-forming and carry the risk of certain unpleasant side effects."
The risk of large, unscheduled payments coming due, including the chance of termination payments, ranked near the top of panelists' lists of potential problems. The credit ratings of swap counterparties, the chance that interest rates and yields will change, and whether swaps require the parties to post collateral also factor into an evaluation of swaps' viability, panelists said.
They agreed that counting on swaps as an added source of revenue, rather than as a hedging mechanism, is nearly always bad policy.
During the two years that Standard & Poor's has used debt derivative profiles, its scoring rubric for municipal derivatives, the rating agency has scored more than 600 derivative products, said associate director Colin MacNaught. This figure averages out to about three swaps analyzed per day and 60 per month, MacNaught said.
But he added that Standard & Poor's has never downgraded a credit based solely on a high DDP score, which would signify high risk. This is partly because the issuer's credit rating plays into its debt derivative profile -- or DDP -- score, MacNaught said.
"The credit fundamentals of an issuer, across all sectors, plays a major role in the DDP analysis," he said, adding that it is also a product of the strength of swaps brought to Standard & Poor's for a score. Of all the DDP scores assigned during the last two years, 78% of them were 2 or lower, meaning the derivatives carried minimal-to-low risk based on Standard & Poor's DDP system.
Fitch does not use a standardized scoring system for swaps or hedges, preferring to factor them into an issuer's overall credit rating, Litvack said.
"No other part of the rating analysis is productized in that way," he said. "We don't take the management analysis and put it through a rubric. We don't take the analysis of their debt structure and assign it a different score for debt structures. So why assign a separate score for swap analysis?"
Analysts noted that the capacity for swaps and variable-rate debt varies by sector. For example, hospitals, utilities, and universities tend to have large investment portfolios, increasing their capacities. The numbers seemed to play that out, too, as 55% of the derivatives scored by Standard & Poor's DDP process were offered by either health care or higher education issuers.
As new forms of swaps are developed, the risks will stay largely the same, analysts said.
"As I've seen derivatives develop, we've seen derivatives using the [consumer price index], fixed maturities, and basis swaps," Litvack said. "They all seem to have the same risks: termination risks and basis risks."
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New PILOT Regulations Under Fire
Posted on Friday, October 20, 2006
Source: Bond Buyer
By Alison L. Mcconnell
The Internal Revenue Service's proposed regulations for payments in lieu of taxes, or PILOTs, could restrict future tax-exempt economic development bond deals, market participants said yesterday.
The regulations, which will not be finalized until after a Feb. 13 public hearing, would tighten tax code rules for PILOTs by requiring the payments to represent a fixed percentage of generally applicable taxes. The regulations signify a new restriction and narrow the interpretation taken by the IRS Office of Chief Counsel in recent private letter rulings issued for the New York City Industrial Development Authority's financing of two new baseball stadiums for the New York Yankees and the New York Mets.
Cities often use PILOT deals, where payments from a private entity are used to pay debt service on tax-exempt bonds, in economic development projects. In a typical transaction a city will take title to a parcel of land, thereby removing the property from tax rolls, and permit a private business to use the exempt property in exchange for payment under the terms of a fixed PILOT contract.
In order to meet private activity restrictions for tax-exempt bonds, those payments must be less than and commensurate with the taxes that would have been collected on the property otherwise. In tax code language, they cannot be "special charges" -- imposed on a limited group of people for benefits to be received only by that group -- but instead must qualify for treatment as "generally applicable taxes," which apply equally to all taxpayers.
The rules proposed yesterday would require PILOT contracts to specify that the payments represent "a fixed percentage of, or reflect a fixed adjustment to, the amount of generally applicable taxes in each year, based on comparable current valuation assessments."
That will "better assure a reasonably close relationship between eligible PILOT payments and generally applicable taxes," the IRS said in the regulations.
The rules would also delete a sentence from the current tax code definition of "special charge" as it pertains to PILOTs because the agency felt an existing definition in another code section was sufficient.
A public hearing on the proposed rules is scheduled for Feb. 17 at 10 a.m. Eastern Standard Time in Washington. The IRS will accept comments until Jan. 16 on the topic of whether any special rules are needed to address PILOTs based on taxes other than property taxes, which are most typically used in the deals.
Market participants reacting to the proposed regulations yesterday said the IRS is taking a narrower approach than it did in two recent private letter rulings issued for the New York City IDA. Those PLRs green-lighted the sale of almost $1.5 billion in tax-exempt bonds for new baseball stadiums for the Yankees and Mets.
The IDA had sought IRS approval of the two transactions -- one for each team -- because no formal PILOT rulings had been issued at that point, according to Nixon Peabody LLP, the firm acting as bond counsel on the deals. The IRS' response approved the structure of the two deals, which involved PILOTs paid by the two teams and contracted to be the amount of debt service on the tax-exempt bonds, rather than a set percentage of generally applicable taxes.
Sources said yesterday that the PLRs' approval of tax-exempt bonds backed by a PILOT contract that looked "too much like a private loan" might have pushed Treasury Department and IRS officials to clamp down in the regulations. But the proposed rules are inconsistent with the way PILOTs are commonly used, one attorney noted.
"The IRS' proposal would reduce the intended financial benefit the governmental entity is intending to provide for the designated project," said Richard Chirls of Orrick Herrington & Sutcliffe LLP in New York. "Tax-exempt bonds will be issued, but at a higher cost, [and] that is not good for the IRS, the municipality, or the developer."
And issuers considering PILOT deals are not likely to rush to market before the regulations are finalized, sources noted.
"Bringing a deal to market in the current legal environment would face the challenge of balancing the ambiguities in the current regulations, as interpreted by the recent private letter rulings for the Yankees and Mets, against the IRS' views as indicated by the requirements set forth in the proposed regulations," according to Chirls. "Prompt resolution by the issuance of final regulations is very important."
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How the Boy Scouts of America Helped to Save Municipal Bonds
Posted on Monday, October 23, 2006
Source: Bond Buyer
By Craig T. Ferris
It doesn't seem possible that Boy Scouts of America saved tax-exempt bonds, but they did.
When the Treasury unveiled in November 1984 what would become the Reagan administration's landmark tax reform proposal, the 461-page plan contained a ticking time bomb for the municipal bond market.
Besides eliminating all private-activity bonds, repealing the deduction for banks to buy and carry tax-exempt bonds, prohibiting all advance refundings, and restricting arbitrage by requiring that all earnings above a certain minimal level be rebated to the Treasury, the massive plan proposed that any governmental bond where more than 1% of the proceeds were used for private purposes would no longer be tax-exempt.
That one proposal, far more than all the others, threatened to drive a stake into the heart of the traditional tax-exempt market and would make it extremely difficult for most state and local governments to issue traditional general obligation and revenue bonds.
The problem was compounded because some major participants in the tax-exempt market wanted to save private-activity bonds, while others were concerned that a separate tax proposal to eliminate the deductibility of state and local taxes would cripple the ability of states and localities to raise taxes.
After much infighting, the so-called Big Seven, which represented both issuers and underwriters, finally reached a consensus that the highest priority for fixing the administration's proposal was to preserve traditional GO and revenue bonds by eliminating or toning down the proposed 1% limit on private use, which in existing law was 25%.
But how could the Big Seven -- which was composed of representatives of the National League of Cities, the National Governors' Association, the National Conference of State Legislatures, the U.S. Conference of Mayors, the Council of State Governments, the International City Managers Association, and the National Association of Counties -- get the message to Treasury and the White House?
At the time, Sen. George V. Voinovich, R-Ohio, was then the mayor of Cleveland and the president of the NLC. He was also " a pretty good friend of then-Vice President George Herbert Walker Bush," according to Frank Shafroth, who was then the NLC's director of policy and federal relations.
"Voinovich -- who is like a bulldog that gets his teeth into your heel and holds on until you've got to do something to get rid of him -- called Bush faithfully for 51 weeks to get the White House to get Treasury Secretary James A. Baker 3d to meet with muni market participants," said Shafroth, who is now the director of intergovernmental relations for Arlington County, Va.
"Finally, the White House told Baker to meet with Voinovich to get him off their backs," he said.
Meanwhile, Shafroth said he finally figured out a way to help NLC members understand the president's 1% proposal and why it would be so harsh.
In an article in Nation's Cities Weekly, Shafroth used an example of the Boy Scouts renting an elementary school in Richmond, Va., after the school year had ended. If the scouts used the school for two weeks, that would exceed the 1% use limit and would make the bonds for that elementary school taxable.
"When the meeting finally took place, it became apparent that somebody at Treasury did a really good job of prepping the secretary," Shafroth said in a recent interview.
Besides Voinovich and representatives of the Big Seven, Ronald Pearlman, who was then the assistant Treasury secretary for tax policy, was sitting at the table.
"Baker walked in -- he didn't do any introductions -- and said, 'Before we start this meeting, I have to ask Ron a question,' " Shafroth said.
"Baker gave the Boy Scout example and Pearlman scratched the right side of his head and said, 'Mr. Secretary, I guess we would have to make a legitimate exception for the Boy Scouts.' "
"I'm at the Red Auerbach stage," Shafroth said, referring to the legendary Boston Celtics coach who would light a cigar when he knew the basketball game was won. "I don't know how Baker got briefed, but the issue is over ... but Pearlman doesn't get it. No one in the room realizes that the meeting is over and the only thing we were trying to obtain was gained."
But he said Baker continued. "'You know, Ron, I know I am from Texas, but I have been in Washington long enough to know if we create an exception for the Boy Scouts, we'd have to do it for the Girl Scouts.' Then Pearlman scratched the left side of his head and said, 'Mr. Secretary, I guess we'd have to do that,' " Shafroth said. "Then Baker said, 'Ron, you don't get it. We'd have to make tens of thousands of legitimate exceptions.' "
"At that point, Baker turned to Voinovich -- remember there have been no introductions and the meeting hasn't started -- and said, 'George, you can go up to the Hill and tell them we don't support our proposal with regard to traditional municipal bonds,' " Shafroth recounted. "The meeting was over."
It would be several more months before a plan would be hammered out in Congress under which governmental bonds would remain tax-exempt if no more than 10% of the proceeds were used by a private entity and a compromise would be reached that allowed private-use bonds to continue to exist under the state-by-state volume cap.
There were a lot of issues left such as how to treat bonds for airports and ports where one or two airlines or users have well over 10% of the usage, Shafroth said.
"My crystal ball was not good enough then" to know how those issues would settled, he said. "But it was good enough to know we had preserved the essential access to the market that was critical for the issuance of tax-exempt bonds."
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The Tax Reform Act, 20 Years Later
Posted on Monday, October 23, 2006
Source: Bond Buyer
By Craig T. Ferris
When the Tax Reform Act of 1986 was signed into law 20 years ago yesterday, many in the municipal bond market thought the future was bleak.
Although the massive measure that was signed by President Reagan on Oct. 22, 1986, was far less punitive to the tax-exempt market than the original White House and congressional proposals that were unveiled in 1983, 1984, and 1985, the historic tax package sent chills through the muni market because it contained the most stringent restrictions ever imposed on tax-exempt bonds.
Market participants expected volume to plunge and some underwriting firms and bond counsel to get out of the market. That happened to some extent, but much of the volume damage was undone within a few years, and the long-term market, which reinvented and rejuvenated itself, now stands at just over four times its size in 1984 when the Reagan administration first launched its tax reform efforts, a year after the initial Bradley-Gephart and Kemp-Roth tax reform proposals.
But there was still a lot of pain and suffering during the three-year debate over tax reform when tax-exempt bond issuers fought to preserve their ability to finance their own operations and facilities, as well as private-use debt that provides financing for housing and other projects that states and localities would have to provide if tax-exempt bonds were not available.
Many of the veterans of those battles have gone into other businesses, have retired, or in some cases have died, but those who are either still in the business or who were there at the time remember the trauma on Nov. 27, 1984, when the Treasury unveiled its tax reform proposal that would have eliminated an estimated two-thirds of the $101.8 billion in long-term municipal debt issued that year.
That plan, which was formally proposed by the Reagan White House on May 28, 1985, was a potential minefield for the muni market. The muni proposals in the plan would have eliminated all private-purpose nongovernmental bonds issued after Dec. 31, 1985, limited private use of the proceeds of governmental bonds to no more than 1%, repealed outright the 80% deduction that banks could take to buy and carry tax-exempt bonds, further restricted arbitrage profits states and localities could earn on invested bond proceeds, and prohibited advance refundings of all tax-exempt bonds.
THE GOAL OF TAX REFORM
The administration's goal for reforming the entire tax code, not just tax-exempt bonds, was to create a fairly pure tax system that eliminated numerous tax preferences, including those for private-activity bonds, that had distorted the code.
"The goal was not to go after the muni market per se. It was to get rid of tax benefits that were riddling the code," according to H. Benjamin Hartley, who was a senior legislation counsel at the Congressional Joint Committee on Taxation when the act was drafted.
But the goal behind both the centerpiece proposals to eliminate private-activity bonds and limit private use of governmental bonds "was to curb what had become an unbridled subsidy to private business," said Hartley, who retired from the JCT in January 2003 and now lives in North Carolina.
The driving force behind the curbs that were eventually enacted in less drastic form was spelled out in the so-called Blue Book, the explanation of the 1986 act that was issued shortly after it was enacted.
"To the extent possible, Congress desired to restrict tax-exempt financing for private activities without affecting the ability of state and local governments to issue bonds for traditional governmental purposes," the Blue Book noted in the section devoted to the reasons for the curbs on tax-exempt bonds.
Between 1975 and 1985, the volume of long-term tax-exempt bonds for private activities increased from $8.9 billion to $116.4 billion.
"As a share of total state and local government borrowing, financing for these activities increased from 29% to 53%," the Blue Book said, arguing that the high proportion of private-purpose debt was driving up the cost of traditional borrowing while allowing high-income taxpayers to earn tax-exempt yields that were nearly as high as taxable investments and creating large revenue losses for the Treasury.
In the ensuing seesaw House and Senate legislative battle, representatives of muni issuers, underwriters and bond counsel succeeded in convincing congressional tax writers to protect traditional governmental and revenue bonds by reducing the 25% limit on private use to only 10% instead of the proposed 1%.
Then rather than eliminating all private-activity bonds, the tax writers agreed to save the tax-exemption for single-family mortgage bonds, multifamily housing, small-issue industrial development bonds, student loans, and exempt facilities by placing them under a state-by-state volume cap, while eliminating the use of tax-exempt bonds for privately owned pollution control, water, sewer, and solid-waste facilities;, sports, convention, and trade show facilities; parking, and industrial parks. Both single-family mortgage bonds and small-issue IDBs were to be eliminated in a few years, but after a roller-coaster ride that involved several reprieves and lasted until the early 1990s, both were finally extended permanently.
VOLUME CAP
The volume cap salvation of private-use bonds was the brainchild of the late Bruce F. Davie, the chief tax economist of the House Ways and Means Committee, who conceived the idea of a unified volume cap that kept the lid on issuance, but left it up to the states to decide how much cap to allocate to each category of bonds. The final bill set that cap at $75 per resident with a minimum of $250 million for small population states, but included a provision requiring it to drop to $50 per capita, or a minimum of $150 per state, on Jan. 1, 1988. (Muni market participants, however, succeeded 14 years later in convincing Congress to increase incrementally the cap back to $75 per resident with a small-state minimum of $225 million, and then to index it for inflation starting in 2003. It now stands at $80 per capita or $246.6 million per state, whichever is greater.]
Davie, who died at 67 in 2003 while working for the Treasury's Office of Tax Analysis, had worked on the separate volume caps for single-family bonds and small-issue IDBs that were enacted earlier in the 1980s, and he felt strongly that as long as there was a limit on the total, it should be left up to the states to decide how much should be issued for each permitted category of bonds.
"Here's the limit, the states can decide how to allocate it," he said in 1986 while explaining the House bill.
Davie, often described as a "big picture guy" by fellow staffers, also was a strong advocate of arbitrage rebate, which was first enacted by the House and then included in the final bill.
Rather than setting up intricate arbitrage rules and exceptions, Davie said at the time that the concept was simple. "You can earn all the arbitrage you want beyond a minimum permitted amount, and then you simply send a check to the Treasury for the excess," he said.
In addition to the arbitrage curbs, the final bill also imposed other tight curbs on muni bonds, including the following major items:
- Advance Refundings: Only one for governmental and 501(c)(3) bonds issues after Dec. 31, 1985, and none for private-use bonds.
- Alternative Minimum Tax: Individual and corporate holders of private-activity bonds subject to the AMT.
- Bank Interest Deduction: 80% deduction for banks that buy and carry tax-exempt bonds eliminated except for banks that buy public-purpose bonds from jurisdictions that issue $10 million or less per year.
Although a final bill was hammered out by a House-Senate conference committee on Aug. 16, 1986, the muni market was in an almost constant state of turmoil for nearly a year from the time the House approved its version of the bill on Nov. 25, 1985, to June 24, 1986, when the Senate approved its bill, and then for the nearly two months until negotiators agreed on a final compromise measure.
That seemingly endless year also included the muni market's equivalent of the stock market's 1929 Black Friday, when on March 19, 1986, Sen. Bob Packwood, R-Ore., proposed phasing in a plan to subject all tax-exempt bond income to a 20% alternative minimum tax in five years.
The bond market, thrown into chaos, shut down completely for a day and trading was skittish until the proposal was rejected by the committee the next week.
When the bill was signed 20 years ago, some gave a sigh of relief because the traditional GO and revenue bond market had been largely spared and private-activity bonds were still alive, albeit under the stringent volume cap. But many in the muni market thought the market might be a shadow of itself.
THE VALLEY OF DEATH
"I truly thought that the market could take a big hit, but that there would be adjustments," said Theodore M. Hester, a partner at King & Spalding LLP here who was involved in negotiations over the 1986 act.
"However, I never thought that Congress was close to putting a real deep cut into the municipal bond market. My perception was that state and local governments had too much political clout, so I don't think that I ever lost hope during the course of that year that there would not be a continuing robust market after the dust settled," said Hester, who served as the president of the National Association of Bond Lawyers in 1989 and 1990, but who left muni bond work later and now does corporate work.
"The immediate concern was that the market ... was going to shrink and change radically," said Micah Green, the president of The Bond Market Association, who joined what was then the Public Securities Association as its chief lobbyist in 1987, a year after the measure became law.
"If you look at that entire package of reforms ... you were looking at fewer bonds being issued, fewer uses of bonds, less ability to manage proceeds due to arbitrage rebate ... and then on the investor side, you had the potential of a narrowing of demand," he said.
And shrink it did.
The long-term market surged from $101.9 billion in 1984 - the year the tax reform drive was started - to a record $207.0 billion in 1985, when there was a rush to market to beat the proposed new restrictions. Even in 1986, the long-term volume remained at $150.6 billion - the second-highest level on record at that time - as numerous bond deals were allowed to go to market under transition rules that were designed to gather the votes needed to get the curbs enacted.
But in 1987, the year after the tax act was enacted, long-term volume declined to $105 billion, according to Thomson Financial. It was not until 1991 that volume hit $172.4 billion and exceeded the 1986 levels, and it was 1992 before that year's $234.7 billion level exceeded the previous record $207 set in 1985.
Not only did market volume decline dramatically in 1987, but "a number of firms got out of the business or cut back and had layoffs," said Terry L. Atkinson, managing director of the municipal securities groups of UBS Securities LLC, who was then working for Salomon Bros., which left the muni market in 1987, then re-entered the market a few years later, and ultimately became part of Citigroup Global Markets Inc.
Beside Salomon Bros., "Rothschild got out of the overall business and you had a number of firms that cut back their muni groups in that fourth quarter of 1987. That was reflective of the fact that new-issue volume had dropped off severely," said Atkinson, who was chairman of the Municipal Securities Rulemaking Board from Oct. 1, 1997, until Sept. 30, 1998.
"If you had told me in 1986 that the [long-term] volume [in 2005] was going to be $408.3 billion, I would have asked you what you were smoking," Atkinson said. "The industry has gone through some tough times - certainly 1986 to 1990 were tough, but it is a much more robust business these days ... a more complicated business," he added, citing the increased use of derivatives.
STRUCTURAL CHANGE
For the housing bond sector, "we thought it was the end of the world ... a disaster, because of the unified cap and the untried [low-income] housing tax credit that replaced passive losses," said John Murphy, the executive director of the National Association of Local Housing Finance Agencies who lobbied on the 1986 tax reform measure.
While it took time to get the low-income tax credit - which offers a 9% credit with conventional financing, or a 4% credit when used in conjunction with tax-exempt bonds - up and running, Murphy says it is now the "single largest stimulus for the production of affordable housing."
But the muni market adjusted "rather quickly to the new volume cap and it was not the disaster that we feared," he added.
One provision of the 1986 tax law triggered a major structural change in the municipal bond market - the elimination of the 80% deduction for banks to buy and carry tax-exempt bonds, according to Christopher A. Taylor, the MSRB's executive director for the last 28 years.
That provision changed the market from an institutional market to an individual one - a shift that drove a lot of banks out of the market or pushed those that survived into dealing with so-called bank-qualified debt, which can still take the 80% deduction as long as the issuer sells only $10 million or less per year.
"What I expected, and what a lot of the board members expected, happened - the structure of the market changed, brokers' and the trading patterns changed, and that has never really recovered," Taylor said in a recent interview.
"We held a retreat in 1987 to reorganize the agenda of the board to address what was going to come down the road as a result of much more retail participation in the market. The long-range plan that was developed basically said that investors are going to demand far more information, and they are going to expect to see what is in the stock market," he said.
That led to three disclosure-oriented priorities: more information about issuers, the characteristics of the security, such as call provisions, and pricing information.
"Those things grew out of the 1986 tax act because you needed to have information for the individual investor if the market was going to grow," Taylor said. "You have to have the trust and confidence of the individual investor in the fairness and integrity of the market. Virtually everything we have done since the 1986 tax act has been geared toward that objective" - even, he said, the board's curbs on political contributions by underwriters to issuer officials.
ILL-FOUNDED
Although NABL officials thought there would be a substantial drop in tax-exempt volume that would lead to a reduction in the group's membership, "I think our most pessimistic fears about volume proved to be ill-founded," in part because bond counsel had more work than they could handle in the three years when tax reform was being debated, said Robert Dean Pope, a partner in Hunton & Williams LLP of Richmond and the president of NABL from 1988 to 1989.
"The fact that [volume and membership] didn't drop [in the long term] is in part recognition of the creative geniuses of bankers and lawyers to find ways to deal with those restrictions, such as the private-activity bond tests," he said.
The tax reform act both changed the economics of the bond law profession and made it more complicated, and meant that bond lawyers had to spend more time on deals, according to Pope, who also served on the MSRB from 1996 to 1999. "But we certainly learned to live with it."
"The 1986 act was a significant part, but not the sole part, of a long-term trend that has made the practice of municipal bond law more federal-tax intense. If you go back to pre-1986 and certainly pre-1982, and you did a general obligation bond for a court house, it was pretty difficult to foul up a tax exemption," he said.
"But the 1986 act, with things such as the rebate and the 2% limit on issuance expense for private-activity bonds, [means] that almost every transaction has significant tax issues," Pope said.
That means deals are a lot more complicated. "Some of that is inevitable ... but there are some things that came out of that era that I think have needlessly complicated transactions and created additional transaction costs for governmental borrowers that could be repealed," such as the 2% cost of issuance limit, he said.
"I think the 2% rule cannot be justified as a matter of public policy ... we spend huge amounts of time dealing with that without either affecting the dollar amount of fees or having any effect on volume," Pope said.
He also criticized the so-called TEFRA requirement that public notices and hearings be held in conjunction with private-activity bond deals as regulation "that does the Treasury no material good" and imposes added costs. "I think they are a burden on state and local government and nonprofit organizations without a corresponding benefit to the federal government," he said.
"Then there is the double whammy of having both yield restriction and rebate which imposes a lot of legal requirements" on issuers, he added.
However, Pope feels that the 1986 act was correct both in reducing the amount of private use permitted in a governmental bond from 25% to 10% and limiting governmental bonds to one advance refunding.
"It is very hard to argue that there should be an unlimited right to do any number of advance refundings," especially when before 1986 there were some deals that were advance refunded eight or 10 times, he said.
BROADER REGIONAL BASE
The 1986 tax act also indirectly led to changes in bond law firms, according to Amy Dunbar, who was NABL's director of governmental affairs from 1988 to 2001.
There was a fear that bond law would become too complicated, and a lot of smaller firms would get out of the practice, which would evolve into New York-based tax practices, said Dunbar, who as a first-year bond lawyer was dispatched to Washington to track the tax bill in 1986 by Jim Perkins, then-NABL president and currently a retired partner at what is now Boston-based Edwards Angell Palmer & Dodge LLP.
"Ironically, if anything, it had the opposite effect," Dunbar said. Some big firms, such as Mudge Rose, disappeared, while some other bond lawyers in large firms have tended to split off, creating a situation in which many bond lawyers are now in smaller, more regional firms.
"You still have a concentration of big deals in the big firms, but now you have a broader more regional base ... and a lot of lawyers that would have been in mega firms are now in smaller firms," Dunbar said.
Meanwhile, other bond attorneys say privately that the changes in the tax act meant the same number of bond counsel were chasing a smaller number of transactions, which meant compensation went down while the workload went up.
One major plus that emerged from the tax reform battle was a new spirit of cooperation among the various groups representing market participants, particularly the public interest groups.
"We were all working together on everything because we all felt if we didn't we would suffer a huge defeat," said Catherine L. Spain, who served as director of the Government Finance Officers Association's federal liaison center from 1982 to 1997.
"Everything was so bad that everybody really had to come together ... and work together to save as much as we could ... it was overwhelming," said Spain, now the director of the National League of Cities' center for member programs.
"I don't think that we thought it would be devastating, but we were concerned about demand-side issues [involved with the alternative minimum tax] and arbitrage ... plus we were concerned about making a distinction between the airport and port type of facilities ... those bonds that we never felt were private-activity bonds," she said.
"But we felt that governmental financings were going to be generally in pretty good shape, and that's what we cared about the most," Spain said.
ANTHONY COMMISSION
About a year and a half after the ink dried on the tax reform act, then-Rep. Beryl Anthony, D-Ark., who was a member of the House Ways and Means Committee, formed the Anthony Commission on Public Finance to study what tax act provisions were causing municipal bond issuers the most trouble.
The 20-member group included an impressive list of market participants, such as then-Arkansas Gov. Bill Clinton, plus several prominent city, state, and county officials; bond lawyers, including NABL's Pope; underwriters, rating agency officials, and a former assistant Treasury secretary for tax policy. They spent the next 18 months drafting a report proposing ways to roll back the most onerous curbs.
That report, released after members acknowledged that they had disagreed among themselves about how ambitious their recommendations should be, suggested modest changes and urged compliance with the tax laws.
Most of those recommendations have never been adopted, although three finally became law and a few others have been on Congress' radar screen at one time or another over the last 17 years.
The group's most innovative proposal called on the federal government to create a public-private partnership bond so that some types of projects owned and operated by private entities could be financed with public-purpose bonds.
That ambitious proposal has never gone anywhere, although a very limited pilot project was enacted by Congress last year that allows up to $15 billion in private-activity bonds that are exempt from the volume cap to be issued to allow private firms to finance transportation projects.
The three proposals that did make it into law were: A waiver of the arbitrage rebate requirement for issuers who spend 95% their proceeds within two years under a specific schedule (rather than spending 95% of proceeds within three years, as proposed by the commission); making permanent the tax-exemption for single-family mortgage revenue bonds and small-issue IDBs; and repeal of the so-called Harvard rule, the $150 million limit on outstanding bonds of private nonprofit institutions other than hospitals, a measure that was successfully enacted through the efforts of the late Sen. Daniel Patrick Moynihan, D-N.Y.
Proposals that have been discussed, but have never gone anywhere, include: exempting tax-exempt interest from the AMT; ending the restriction that limits to 5% the amount of bond proceeds that may be used for a non-governmental purpose; repealing the $15 million limit on the private-use portion of a bond issue used to finance public power projects; and increasing the small-issuer bank exemption to $25 million from $10 million.
Although Anthony, who had become the main tax-exempt bond champion in Congress, pushed many of the proposals in legislation he introduced in 1991 and 1992, his efforts came to an abrupt halt in late 1992 when he failed to win re-election to his House seat.
While commission members vowed to continue his work, the group has never met since Anthony's departure.
But the Anthony commission put a different face on tax-exempt bonds.
MORE EXCEPTIONS NEEDED
"The idea of the Anthony Commission was to say that in some respects the 1986 act went too far and there are ways to deal with what Congress thought were abuses without restricting virtually every transaction," said Mitchell Rapaport, a partner at Nixon Peabody LLP here.
The easing of the arbitrage rebate rule, if proceeds are spent in two years, "was one of the rare examples since 1986 where one of the restrictions imposed was recognized by Congress as having been more extreme than was needed," said Rapaport, who was an IRS assistant branch chief in the legislation and regulations division when the 1986 law was enacted and later served in the Treasury's Office of Tax Policy.
"Although it is a help, more rebate exceptions are needed. For example, the small-issuer rebate exemption has not increased in size since enactment, and you have a lot of small issuers who have the compliance and other costs imposed on them for little or no benefit to the Treasury," he said.
But rolling back or refining restrictions is difficult, both because "once these rules get enacted, any change you try to make means you have to get Congress and the administration comfortable that it makes sense policy-wise, which is especially difficult because of the complexity of these issues" and because the revenue impact is typically a problem, Rapaport said.
While only a few of the panel's proposals were ever enacted, Dunbar thinks the efforts of the Anthony Commission helped the image of the municipal market.
"I think it created an environment in which Congress understood that the muni world wasn't greedy, that they were coming at it from a public purpose perspective ... they were thinking as state and local governments," she said.
"We succeeded in putting the state and local government face on bonds instead of what, in the 1986 act, was perceived as the banker-lawyer face, and having a champion made the committee staff understand we had to be dealt with in an upright manner and as state and local governments," Dunbar said.
20 YEARS LATER
"I never thought [the effect on the market] would be a drastic as [the New York muni people] were telling us," said former JCT staffer Hartley, who was known in bond circles as the Prince of Darkness for his ability to draft legislation that plunged stakes through the heart of bond provisions perceived to be abusive.
"The bond title [of the act] did not raise that much - about $2.5 billion to $3 billion - because we gave away so much in the transition rules," which allowed some $25 billion in bond deals to go forward to get the votes needed to pass the bill, Hartley said in a telephone interview from his retirement home.
Despite the volume cap, which reduced private-activity bond issuance to about 6.4% or $26 billion of the $408.3 billion of long-term bonds issued in 2005, "there is still a lot of capacity there ... even at $50 [per resident] there were a lot of states that were not using their cap," he said.
Twenty years after the tax reform act became law, "while curbed, the market is still able to do what it wants to do," says Hartley, who believes that the market is better off for having gone through tax reform.
"On the whole, it's cleaner because it was heading down a route that would have gotten it into trouble one way or the other back in 1985 and 1986. I think people are more cognizant of trying to watch what they do than they used to be," he said.
"I think the market is better off ... because I am amazed when I look at other areas of the code how basically intact the muni section is," Hartley said. Despite wholesale rewrites of the corporate, international, and individual side, "about all you have had has been some tweaking around the edges of the core [muni bond] piece of the tax code."
Former GFOA lobbyist Spain, who has not been involved with municipal bond policy for the last 10 years, believes the 1986 curbs did not have that much of an effect on tax-exempt issuance except for the volume cap.
But there were added costs to comply with some of the new restrictions, such as the arbitrage rebate requirement. "Many of us felt it was costing us a whole lot more to comply with the rebate than Treasury was collecting. In the end, a lot of the burdens were regulatory ones ... with more regulatory costs," she said.
And former NABL lobbyist Dunbar believes the private-use curbs made issuing traditional GOs and revenue bonds a lot more complicated and created a whole new "industry of compliance - lawyers, accountants, and government employees - that has come into play to make sure all the complications that were added by that law are, in fact, met."
That has also led to the evolution of IRS enforcement, she said, while others argue it has played a role in stepped-up Securities and Exchange Commission enforcement, particularly with cases in which enforcement officials charge the players should have known bonds were not tax-exempt.
Despite the difficulties created by the bond curbs, Rapaport points out that all financial markets, including the municipal bond market, have evolved considerably in the last 20 years, and that has helped the muni market.
"For example, now that derivatives have become so commonplace, to some extent they can be used to help deal with some of the limitations of the tax law," he said. "For example, suppose you can't do an advance refunding because you have already advance refunded the bonds, you may be able to do a forward swap to lock in the same kind of benefits."
"Those kind of things have allowed the industry to adapt and evolve so it can make the best of the situation," Rapaport said.
For TBMA's Green, the 1986 law was a "major wake-up call," as was the landmark 1988 Supreme Court decision in South Carolina v. Baker that concluded the tax-exempt status of municipal bonds is not guaranteed by the Constitution, and it is up to Congress to decide if the tax exemption should be retained.
"Those were wake-up calls that the state and local community needs to get together and work in a coordinated way" to convince Congress the tax-exempt bond market is valuable for the country, he said.
While the tax-exempt market has its detractors in Congress and the Treasury, and could be a target in any future tax-reform drive, Green believes the market can defend itself.
"There will be those at Treasury and JCT that will continue to view the municipal bond market as a tax expenditure that governors and mayors control and not the Treasury," he said. "The fact is, it is a subsidy to states and localities, but it is not a full subsidy ... it is just seed money. It is a partnership, and I think more and more federal policy makers are looking at it as a really good partnership. So we hope in the context of any future tax reform that [the partnership] would be looked at as a way that the federal government can actually get needed activity out there - building roads, school, and other infrastructure - for less cost than if the federal government did it itself."
Despite the turmoil that the 1986 tax act meant for the municipal market, many look back and believe the massive bill was good both for the nation and for the tax-exempt market.
"I think, for the most part, it was really good reform," said Frank Shafroth, who is now the director of governmental affairs for Arlington County, Va., and was the National League of Cities' director of policy and federal relations when the 1986 act was enacted.
"Not only did it preserve fundamental access to capital markets that is critical to state and local governments, but it substantially helped with the [federal] deficit, and it really cleaned up the code," he said.
"From a macro policy standpoint, it was the right thing to do, and from a municipal standpoint it preserved essential tools critical to state and local governments," Shafroth said.
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A Vague Future For Tax Reform
Posted on Tuesday, October 24, 2006
Source: Bond Buyer
By Alison L. McConnell
As the 1986 Tax Reform Act's 20th anniversary passed Sunday, it was clearer than ever that another round of fundamental, comprehensive changes to the tax code is a dim possibility that is largely dependent on the outcome of the upcoming elections and the leadership priorities of the incoming 110th Congress.
Since President Bush said in his 2005 State of the Union address that federal tax reform was a top objective for his administration, Hurricane Katrina, gas and home prices, the ongoing war in Iraq, terrorism, and immigration issues have all taken a front seat to the arduous process of undoing thousands of complications added to the code in the past two decades.
Yet a handful of lawmakers are poised to act on tax reform in 2007 and aim to schedule hearings after the election haze subsides. Municipal market groups - after mounting familiar, time-worn defenses when an advisory panel last year recommended changes detrimental to the tax-exempt bond market - are keeping a watchful, wary eye on the proceedings to ensure that state and local government interests are recognized in a complex federal debate.
Over the past two years, Senate Finance Committee chairman Chuck Grassley, R-Iowa, the panel's top Democrat, Max Baucus of Montana, and committee member Sen. Ron Wyden, D-Ore., have emerged as key catalysts in the debate. Grassley held three committee hearings in 2006 and said in a recent interview that he is planning more.
"Every time Sen. Wyden and I run into each other in the hallway or on the Senate floor, we have one-on-one discussions on how to go about that next year," he said.
But beyond the handful of hearings and member proposals for reform, including Wyden's Fair Flat Tax Act, progress on tax reform has been snail-like. The President's Advisory Panel on Federal Tax Reform - a nine-member, bipartisan commission, spearheaded by former Sens. Connie Mack, R-Fla., and John Breaux, D-La. - held 12 public hearings around the country last year. After Katrina-related deadline extensions, it presented its findings in two controversial proposals that received simultaneous flak and praise.
Both plans would retain the tax-exempt status of municipal bonds and repeal the individual and corporate AMT; measures welcomed by state and local governments. But they would also eliminate the deductions currently available for mortgage interest and state and local taxes, as well as alter the taxation of investment income in ways that market participants say will shrink demand for munis.
The first proposal, dubbed the Simplified Income Tax Plan, would tax all interest earned by corporations on tax-exempt bonds. The second plan, the Growth and Investment Tax Plan, would not tax investment income, be it from bonds or otherwise taxable investments, earned by any corporations except financial institutions.
After warmly welcoming the final report last December, the administration fell nearly silent on the issue of tax reform. Bush did not mention it in his 2006 State of the Union address, and Henry Paulson Jr., who took over from John W. Snow as Treasury secretary in July, has said the department is still working through the panels' recommendations. White House and Treasury media officials did not return calls for comment for this story.
"The things that we're going to have to do to get our fiscal house in order are going to be very challenging, and in many cases not popular," U.S. Comptroller General David Walker said in an interview last month. "It's unfortunate that the panel's report has not really gained much visibility and doesn't seem to have traction. [It] did very good work and came up with a number of recommendations that deserve serious consideration."
Grassley said the best chance of making meaningful progress on tax reform would be Bush reviewing the report, modifying it any way he wants, and making recommendations to Congress. "I think that gives it impetus. Short of that, we're going to have to sit down in bipartisan way in the Finance Committee and try to work out what we can," he said.
Wyden said he has been encouraged by Grassley's initiative on the issue and by constructive conversations with Paulson, White House chief of staff Josh Bolten, and National Economic Council director Allan Hubbard.
"I've been talking to the administration about this constantly" since introducing the flat tax legislation a year ago, Wyden said. "They've always been very cordial and interested in details. I think they're thinking about what their priorities are going to be for '07."
On the House side, the potential for movement on tax reform is complicated by an impending handover in leadership. Ways and Means Committee chairman Bill Thomas, R-Calif., has announced he will not seek re-election this year, and Rep. James McCrery, R-La., Nancy L. Johnson, R-Conn., and E. Clay Shaw Jr., R-Fla., are considered potential GOP successors.
Rep. Charles Rangel, D-N.Y., currently the ranking Democrat on the panel, could become chairman if the Democrats win control of the House in two weeks. He has said one of his top priorities as chair would be tackling the alternative minimum tax, which was originally created to ensure high income-earners were paying their fair share of income taxes.
Since the AMT is not indexed to inflation, however, it has increasingly ensnared middle class taxpayers and has become a frequently cited example of the need for reform. Municipal market groups have applauded several proposals to repeal the tax, since it applies to interest earned on private-activity bonds. Corporations must also include interest earned on some governmental and 501(c)(3) bonds in earnings and profits for their AMT calculations.
While many said the party affiliation of Ways and Means' next chairman is a vital element, Rep. Dave Camp, R-Mich., chair of the panel's subcommittee on select revenue measures, is also pushing the tax reform envelope. He held two hearings on member proposals this year and plans to put more on the calendar in 2007.
"Particularly as you look at the U.S. staying competitive, we must address fundamental tax reform. It is important as we try to keep the economy growing that we find a way to reduce the tax burden," whether that is through compliance or lower rates, he said.
MARKET RESPONSES
As congressional and administration officials have taken up the mantle of tax reform, municipal market groups have dusted off defenses utilized in past challenges to the tax exemption of municipal bonds and other subsidies afforded to state and local governments.
The advisory panel's recommendations, they say, make the federal tax code simpler at their expense, because leveling the tax preferences between different types of investments could reduce demand for municipal bonds and force issuers to borrow at higher costs.
"You've got proposals that on the surface appear to clean up the corporate side of the tax code, but do harm to the very economic foundation for corporations to compete in the global economy" - the ability of states and localities to finance the construction of "airports, highways, and other means to deliver people and products to their clients in the global economy" with bonds, according to Frank Shafroth, director of intergovernmental relations for Arlington County, Va.
No one on the tax reform panel represented those interests, he added, so no one said, " 'Let's step back for a minute and think through the implications of the change we are proposing.' "
Advocate groups such as The Bond Market Association are working to counteract that lack of unawareness in Washington. TBMA is maintaining a "daily" effort to educate members of Congress and their staffs about the effect of tax reform proposals and the key role municipal bonds play in infrastructure finance, according to Jill Hershey, senior vice president for legislative affairs.
Hershey said it is crucial that market participants continue to collectively "send, sell, and advocate the message of why municipal bonds and their tax exemption is important [so] we don't become a tradeoff for a larger priority. Hopefully we can continue to speak with one voice and be unanimous in our approach."
Panel chair Mack, now a senior policy adviser at King & Spalding LLP here, acknowledged the significant nature of changes proposed for the tax treatment of various investment alternatives, including munis, but defended the measures: "The argument I would make is that the distortions that exist in the present code would be dramatically reduced with the reform package we developed," he said.
Regarding the elimination of the state and local tax deduction, which muni groups say impairs state and local governments' flexibility to raise taxes to meet revenue needs, Mack said: "It was just a question of what's the right policy? Should the federal government in essence be subsidizing - beyond the ability to get financing in the market - local and state expenditures? The feeling was that a reformed tax code should not include that subsidy."
Rep. Phil English, R-Pa., a tax reform proponent who introduced "Simplified U.S.A. Tax" legislation in February, pointed out that it would be difficult to maintain the deductibility of state and local taxes in a fundamentally simplified and equitable tax system.
"This is an issue that is going to have to be confronted directly," he said. "I don't believe that a taxpayer should be contributing less to federal coffers because he or she chooses to live in a high-tax jurisdiction. This is one of the critical issues that we're going to face, and one that I think will require us to put the big picture ahead of the concern of municipal officials."
An update of a Congressional Research Service report, released Sept. 28, acknowledged that eliminating the state and local tax deduction would affect the distributional burden of taxes across the three levels of government.
"State and local governments might be less willing to finance projects that generate benefits that extend beyond the taxing jurisdiction," but the magnitude of the effect would depend "significantly" on the response of states and municipalities to federal changes, the report said.
John Murphy, director of the National Association of Local Housing Finance Agencies, theorized that the deduction is likely to be retained. "I almost see a parallel there with the Bush administration's proposal to eliminate the [Community Development Block Grant] program two years ago, when we spent so much time and effort on mobilizing virtually every elected official in the country," he said. "I would see the same kind of reaction to that proposal."
Fundamental tax reform advocates have indicated, and confirmed in interviews this fall, that an elimination of the tax exemption for municipal bond interest remains relatively unlikely.
"In the grand scheme of things, there's always been the sense of the importance of access to markets by state and local governments, and I don't think at this point that was something we wanted to tamper with," advisory panel chair Mack said.
But Grassley cautioned that it was too early in the debate, in general, to rule out any particular measures. "You have to assume that everything's on the table. Now, will everything, including that, stay on the table? Probably not. But I don't think I want to venture a guess right now" about what types of reforms are more likely to be passed or dropped, he said.
The debate is not wholly negative for the tax-exempt bond market, as some tax reforms could boost issuance and demand, according to sources. Susan Gaffney, federal liaison director for the Government Finance Officers Association, said many tax code provisions enacted in 1986 have not been looked at since, and are therefore "quite out of date." She cited bank-qualified debt as an example; a provision enacted 20 years ago - but not updated since - that allows banks to take an 80% deduction on tax-exempt bonds purchased and carried from issuers that sell $10 million or less a year.
Given 20 years of inflation and changes in market practices, the $10 million ceiling is too low, and Congress should increase it, Gaffney said. "We want to help smaller issuers and smaller communities be able to take advantage of the bank-qualified program, and would be proposing that Congress take a look at that in addition to arbitrage rebate and a host of other simplification efforts."
Charles A. Samuels, counsel to the National Council of Health Facilities Financing Authorities and the National Association of Higher Education Facilities Authorities, said for many years the two groups' number-one issue has been an attempt to liberalize those bank deductibility rules, which he called a strong disincentive for banks to purchase small debt.
More recently, the groups have been drawn to legislation that would allow the Federal Home Loan Banks to issue letters of credit for municipal debt, which would benefit small borrowers in both education and health care, he said.
"Unfortunately the IRS a few years ago took the position that these transactions were federal guarantees, which as an economic matter is absolutely not the case," Samuels said. "There is an interest by both banks and our issuers, and others, to provide some opportunities for the Federal Home Loan Banks to be supportive of these issuances."
GENERAL DEFENSES
While market groups have, and continue to push such changes on Capitol Hill, they are also steeling themselves for battles that could come next year. Murphy indicated that the NALHFA will continue to mount a vigorous defense of tax code incentives that stimulate investment in home ownership and rental housing: "We've had to do that many times in the past; we're fully equipped to do it again," he said.
Samuels said muni groups today are constantly on the defensive - much as they were in the mid-1980s - trying to make tax proposals "more rational" and less harmful to the market.
"Either because for revenue gain something [is] proposed, or because the same staff people in Congress and the Treasury don't like tax-exempt bonds, they are always looking for opportunities to put further restrictions on" tax-exempt bond issuance, said Samuels, an attorney with Mintz Levin Cohn Ferris Glovsky and Popeo PC here.
He said the NCHFFA and the NAHEFA are monitoring potentially detrimental tax reform proposals - as well as other legislative initiatives, such as the charitable health care inquiry being conducted by the Senate Finance Committee - to ensure that smaller issuers are not left in the dust.
"Whenever you have new rules come into effect, the smaller and less sophisticated issuers always have a harder time complying. Large issuers or large borrowers; the market finds a way to find them, but that is not necessarily the case for some small colleges, hospitals, [and] health care clinics," Samuels said.
Tax reform should promote a more efficient municipal bond market, according to National Association of Bond Lawyers president Carol L. Lew.
"The most effective way to achieve simplification is to communicate with legislators and regulators regarding the municipal bond market with the intent to educate," said Lew, a partner with Stradling Yocca Carlson Rauth in Newport Beach, Calif. "The association continues to submit to Congress and the executive branch proposals to simplify the tax rules, such as in the areas of arbitrage, derivatives and issue price."
Many muni market groups, including the National League of Cities, have said they are generally concerned about incremental tax changes that have an enormous effect on state and local government finance when taken together.
An example of that incremental "preemption," according to NLC principal legislative counsel Alex Ponder, is the telecommunications bill, which is currently under consideration in the Senate and would restrict the ability of state and local governments to levy taxes and fees on the telecommunications industry.
The NLC sent a letter, co-signed by six other state and local groups, to Senate leaders this summer, stating that the legislation's cumulative effect "runs counter to our federal system and applies a federally mandated command-control model approach to traditionally state and local issues." And about a month later, the NLC released a report on tax reform asserting that decisions made at one level of government affect "the entire revenue food chain" from the federal level down to individual towns and cities.
The GFOA's Gaffney agreed. "There's a desperate need for intergovernmental conversation," she said, citing a report issued in August by the National Academy of Public Administration that called for an enhancement of intergovernmental affairs to manage shifting economic and demographic forces, and to cope with globalization and the open nature of the U.S. economy.
Sound principles of taxation "must be balanced on a whole-of-government basis as much as possible so the national can strengthen its adaptive capabilities," the NAPA said.
Most congressional leaders and federal officials interviewed for this story said state and local government interests were essential considerations in the scheme of federal tax reform.
"We have to understand that in today's world, there are increasing interdependencies and ripple effects from actions by one party on other parties," the GAO's Walker said. It is therefore crucial to understand the federal-state-local relationship and the challenges faced by state and local governments so "we can make a conscious and informed decision about what ought to be done, and understand what the likely implications are," he said.
Walker added that states must confront unique fiscal challenges, such as rapidly growing Medicaid costs and unfunded pension liabilities.
"In the end, we have to come up with national approaches, not federal approaches," he said. "We're all in this thing together and we need to make sure we're ... understanding the other dimensions."
Any proposals for truly fundamental reform, such as a switch to a retail sales tax system, could be problematic because states use the federal income tax as their base, some noted.
"If you try to move to another system of taxation, frankly the income tax must be eliminated," Camp said. "That's a very difficult issue. No one policy has gotten enough consensus to move forward; the flat tax, retail sales tax, and even the president's advisory panel [proposals], which had a combination."
UNENGAGED DEBATE
English said to get the wheels rolling on tax reform, an alignment must form between "the majority party, a significant beachhead in the Democratic party, and strong, focused support from the White House.
"I believe the debate basically remains unengaged, and this is a source of great frustration," he said.
The NALHFA's Murphy questioned whether there is a sufficient appetite for meaningful or comprehensive tax reform at this political moment. "There's just so many interests that would be affected by it that I'm hard-pressed, after being an observer and a participant for almost 35 years, that we're going to see another 1986 again," he said.
Arlington County's Shafroth, who helped negotiate the 1986 Tax Reform Act when he was director of policy and federal relations for the NLC, does not think the current Bush administration will be able to undertake a major tax code overhaul because partisanship is rampant.
"It would take someone to force both major parties to move to the middle and [make people] understand that there are some things that are broken that desperately need to be fixed. But absent a third party coming in and shaking things up, I don't see" a remote possibility that it could occur in the next few years, he said.
The upcoming midterm election will be significant for the tax reform debate. Many sources noted that they are waiting to see what happens Nov. 7 and afterward as new House and Senate leaders detail their priorities for the 110th Congress.
"Sens. Grassley and Baucus said tax reform was going to be high on their list, so from that standpoint we take seriously that the Finance Committee will be looking at it," the GFOA's Gaffney said. On the House side, "we'll have to see where the leadership sits and who is setting the agenda," she said.
Mack said in September that since few domestic issues are major parts of the national debate right now - with the exception of immigration - "there's not going to be much focus on [tax reform] during this election. Beyond that, it's in the hands of the administration and the leadership in the House and the Senate as to whether they determine this is something they want to pursue next year."
A BIPARTISAN COALITION?
Lawmakers from both parties agreed that bipartisanship was one of the most critical components of a successful reform process.
"Nothing gets done in the United States Senate that isn't done in a bipartisan way," Grassley said.
Back in the 1980s, President Reagan effectively invested political capital in tax reform, but the existence of a strong bipartisan coalition really allowed the issue to move forward, according to Camp, who said that "is the only way we're going to be able to see progress" in 2007.
English said it is critical "that reformers take an ecumenical view of the process and that the advocates of a flat tax, the advocates of a fair tax, and the advocates, like myself, of other tax initiatives come together and create pressure for this to move forward next year."
Wyden seemed to agree, noting that it is "a question now of pushing all sides to be willing to make the investment of time and political capital to do it.
"There have been thousands and thousands of changes to the tax code since the last time; three for every working day. I should think both Democrats and Republicans would say, 'We don't need all that clutter,' " he said.
Given how divisive things can be on Capitol Hill, it might take a pivotal issue such as the increasingly burdensome AMT to bring lawmakers together around tax reform, TBMA's Hershey said.
"Obviously there are revenue constraints that have prevented members from taking larger steps, but what we're facing is a nearly eightfold problem in terms of the taxpayers it will affect in 2006 and 2007," she said. "I don't see how [such a] drastic effect can be ignored. It's a very significant issue for taxpayers, investors, and issuers."
At a press conference here yesterday, Wyden and former Sen. Bill Bradley, D-N.J., one of the key drivers of the Tax Reform Act, called for a 1986-style coalition to move fundamental reform forward in 2007.
"Obviously the glue in '86 was the fact that the president and the Senate, particularly Sen. Bradley, built this kind of bipartisan relationship where there was a lot of trust, where they could dig into these substantive issues," Wyden said in an interview earlier this month. "I hope we can build that kind of bipartisan trust again."
(c) 2006 The Bond Buyer and SourceMedia, Inc. All rights reserved.
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September 2006
Partner Sought for Toll Road
Posted on Wednesday, August 30, 2006
By Elizabeth Albanese
Rates Shift May Lead to Refundings Increase
Posted on Thursday, September 07, 2006
By Matthew Hanson
N.Y.C. IDA Gets New Executive Director, OKs $68M of Deals
Posted on Wednesday, September 13, 2006
By Ted Phillips
Myrtle Beach, S.C. Readies Sale for TIF District
Posted on Tuesday, September 26, 2006
By Tedra DeSue
IRS Releases Guidelines For Mixed-Use Facilities
Posted on Tuesday, September 26, 2006
By Alison L. McConnell
Partner Sought for Toll Road
Posted on Wednesday, August 30, 2006
Source: Bond Buyer
By Elizabeth Albanese
Less than a year after pulling from the market a $428 million refunding bond issue, the board of directors of Colorado's Northwest Parkway Public Highway Authority yesterday announced plans to seek a private partner to operate and manage its struggling Denver-area toll road.
If the authority reaches an agreement with a private partner, all of the outstanding debt issued by the authority in 2001 would be defeased, officials said.
"We have not spoken to the bondholders about this possibility because it's not necessary -- all of the debt would be eliminated," said Chris Berry, the chairman of the parkway authority's board of directors. "We have been in contact with the trustee, and will continue to be in contact with the trustee as long as there are bonds outstanding."
Berry said that if no concessions agreement was reached for the 11-mile toll road, the authority would "continue to review options to refund existing debt."
RBC Capital Markets Inc. serves as the authority's financial adviser and will assist the board in its reviews of concessions proposals.
The decision to seek additional proposals comes in the wake of an unsolicited proposal received by the authority earlier this year. The agency declined to reveal either the identity of the party that submitted the bid or the details of the proposal. Since receiving that initial inquiry, officials say they have discussed the possibility of a concessions agreement with a total of five interested parties.
To date, toll road agencies that have entered into such partnerships include the Chicago Skyway, the Pocahontas Parkway in Richmond, Va., and the Indiana Toll Road. In addition, officials in Texas are working with a number of private partners and potential private partners to build transportation projects, including a $6 billion agreement with a consortium known as Cintra-Zachry to build a 316-mile corridor running from near the Mexico border to North Texas, just short of the Oklahoma border.
The Northwest Parkway currently has three local government partners -- the city of Bloomfield and Lafayette and Weld counties. Any funds in excess of the bond repayment realized via a concessions agreement would be divided among those parties, and the toll road, at the end of the contract, would revert back to their ownership.
The parkway authority would remain intact throughout the lifetime of that agreement, although Berry said he was unsure how the agency would be structured.
He added that at this time, the authority has not placed any dollar amount on either the worth of the toll facility itself or its revenue potential over the next half-century.
A tentative timeline has the authority soliciting and reviewing proposals throughout the fall, with expectations of signing a letter of intent with a lease equity partner by the end of 2006.
Berry said that despite the possibility of a private partnership, the authority has not dismissed the possibility of refunding existing bonds. He said, though, that 40 years is the maximum lifetime allowed for municipal toll revenue bonds, while most concessions agreements last 50 years. That extra decade, he said, gives private investors more time to realize a maximum return.
In December 2005, the authority pulled a $428 million refunding of its Series 2001 toll revenue bonds from the market. Parkway officials said that although the underwriting team worked for more than a week to get the deal completed, the sticking point was the interest rates offered for approximately $220 million of subordinate bonds included in the transaction.
Several investors said at the time of pricing that they did not feel comfortable buying subordinate debt with a 40-year final maturity. In the end, the parkway authority's board opted to cancel the offering altogether rather than accept the higher-than-expected yields.
Bear, Stearns & Co. and George K. Baum & Co. were the underwriters for the transaction.
The deal was originally expected to provide debt service savings that would allow the authority to recover from a slower-than-expected ramp-up period for the arc-shaped toll road that connects with two other road segments to form a loop around the city of Denver.
Original forecasts for the parkway indicated much heavier traffic, but expected development in the area, as well as reduced traffic at nearby Denver International Airport following the terrorist attacks of 2001, have been blamed for the Northwest Parkway's sluggish -- albeit improving -- performance thus far.
At the time the 2005 refunding was conceived, the parkway authority faced a downgrade of the original debt issued to finance the project in 2001, and officials hoped to avoid a ratings event via the refunding. Following the failure of the refunding deal to yield favorable results, the parkway's debt was downgraded by all three rating agencies.
Currently, Standard & Poor's rates the authority's senior debt B-minus, while Moody's Investors Service rates it B1, and Fitch Ratings rates it BB-minus. The senior debt is insured by Financial Security Assurance Inc. and Ambac Assurance Corp.
The uninsured subordinate bonds carry ratings of CCC from Standard & Poor's and B3 from Moody's. Fitch did not rate the authority's subordinate debt.
The uninsured subordinate bonds last traded on May 26, 2006 when a block of 500,000 due June 15, 2041, with 7.125% coupon was sold at 108.348 to yield 5.75%.
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Rates Shift May Lead to Refundings Increase
Posted on Thursday, September 07, 2006
Source: Bond Buyer
By Matthew Hanson
In all but one month this year, the 2005 refunding statistics dwarf this year's totals. But bankers and financial advisers hint that a new window of favorable interest rates could herald a bounce in refunding volume this fall, as issuers near call dates or try to make up for missing out in 2005.
Last year saw issuer after issuer taking advantage of historically low interest rates, pushing the total par of refunding issuance to $130.7 billion - the most in 12 years. Through the first eight months of 2006, refundings were off last year's pace by 56.6%, according to Thomson Financial data.
But municipal bond yields dropped to annual lows last week, making it the best time of 2006 to save money through refunding debt.
"Right now rates are good, and we hope they're going to get a little better through September - maybe even into October," said Richard Tortora, president of Capital Market Advisors LLC. "If that's the case, we might be able to get a half dozen refundings done."
This could mean a total of $200 million of refunding deals for CMA's clients during the next few months, Tortora said, adding that he recommends exchanging original bonds for new rates as soon as the client can realistically expect 3% in present value savings from the deal.
"We recommend: bird in the hand, then let's go now, especially in these kind of uncertain times when something could blow up in the market, or rates could go up again, or some strange economic news could come out," he said. "We'd rather just seize the opportunity in the current environment, count our blessings, and move on."
With last week's bond yields averaging at yearly lows, financial advisers said that they're ready to market refundings they tabled in the spring and that they will start preparing debt offerings for other clients.
The Bond Buyer revenue index decreased to 4.91% last week, down two basis points from the previous week's index. The 20-bond index dropped four basis points to 4.30%, while the 11-bond index shaved five basis points to average 4.25%.
All three of these measures represented new annual lows, each down 40 basis points or more from the highs set at the end of June.
These are still greater than last year's lows, which were the best in several decades for issuers. But they have opened refunding windows, the environment during which potential savings make refundings viable options, for issuers nearing a call date or wishing they re-issued their debt last year.
Two Utah credit refundings that were tabled in the spring are now headed for market, said Laura Lewis, principal at Salt Lake City-based Lewis Young Robertson & Burningham Inc. The firm is acting as financial adviser for the two issuers, West Valley City and South Jordan, which will both refinance existing debt this month.
Lewis said her firm has been monitoring rates recently, ready to sell the authorized debt as soon as conditions ripened.
"My staff knows how many ticks we need to see go down - we typically use the 10-year Treasuries as flat as the yield curve has been," she said, referring investment returns issuers can obtain in the Treasury market. When borrowers execute advance refundings, they use the newly issued bonds to purchase Treasury securities, which generate revenue over time to pay off existing bonds as they become callable.
For Portland, Ore., a combination of approaching call dates and improving rate conditions prompted officials to schedule a $43.1 million refunding for next week, alongside the sale of $67.1 million of new-money debt. Both transactions relate to the city's water system.
"Given where rates have gone, we probably would have done the refundings on a stand-alone basis," said Eric Johansen, Portland's debt manager. "But the new offering certainly made it easier to go ahead and do it now."
The refunding includes one series of 1997 bonds that are callable in August 2007 and a series of 2000 bonds callable in 2010, Johansen said.
Like many jurisdictions, Portland has guidelines on when and for how much a bond can be refunded. For the city to refund bonds callable in less than a year, there must be at least $100,000 in total present-value savings available in the deal, Johansen said. The city also mandates that advance refundings must provide 5% in present-value savings, even more stringent than Oregon's state requirements.
Portland has about $2.5 billion of outstanding debt right now, and Johansen said he is monitoring other issues for possible refundings.
"The universe of refundable issues is smaller than it has been in the past because we've already refunded some of the things we needed to, but every now and then we'll get close to a call date and something like this will pop up," he said.
But many of the biggest advance refunding deals were done during that past few years, limiting the number available for both advance and current refundings now.
"You don't have enough of the advance refunding candidates that are going to trigger new present value savings that they hadn't hit before, especially with rates somewhat higher than they were in that '02 to '05 period," said George Friedlander, managing director and fixed-income strategist for Citigroup Global Markets Inc.
This also was the outlook of Kenneth Fullerton, principal at Fullerton & Friar Inc. His firm is financial adviser for the Tampa, Fla.-based Hillsborough County Aviation Authority, which plans to price a $32.9 million refunding today.
"People are looking at it more, but we don't have any other refundings that are purely for savings in the near future," Fullerton said. He added that the HCAA has been watching the market all summer with plans to refund before an Oct. 1 call date. But he added that the HCAA opted for a fixed-rate sale in light of the recent drop in interest rates.
Friedlander said it is likely that fourth quarter refunding will pick up, as compared to the rest of 2006, but added that he does not expect it to become an ongoing trend.
"The refunding bulge lasted from '02 through '05," Friedlander said. "That period is over, so you can get some bounce-backs month-to-month or quarter-to-quarter, but it's all on a lower base."
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N.Y.C. IDA Gets New Executive Director, OKs $68M of Deals
Posted on Wednesday, September 13, 2006
Source: Bond Buyer
By Ted Phillips
The New York City Industrial Development Agency promoted Kei Hayashi to executive director and approved up to $68.5 million of bonds for four projects at the monthly board meeting yesterday.
Hayashi moves up from her post as the deputy director, replacing Steven M. Berzin who resigned. Maureen Babis is the IDA's new deputy director.
Hayashi started at the New York City Economic Development Corp. and its subsidiary, the IDA, as a project manager in 1995. As senior vice president and deputy executive director, she managed finance teams that put together bond and incentive programs to foster economic development in the city. She joined the agency after five years at New York Consulting where she analyzed operations for manufacturing and nonprofit clients.
Hayashi didn't get her start in finance. She earned a bachelors degree in classics at Wesleyan University in 1987 and then began work at the Regional Plan Association as a research assistant. After graduating with a master of public affairs from Princeton's Woodrow Wilson School of International Affairs in 1992, she worked for New Jersey Senator Frank Lautenberg as a legislative assistant.
As for bond approvals, the board cleared $40 million of revenue bonds for a parking garage in East Harlem that could cost up to $90 million. Tiago Holdings, LLC -- a joint venture of Forest City Ratner and Blumenfeld Development Group -- will build the 8-story, 1,250-spot parking space facility. The garage will be part of the East River Plaza project, a planned 500,000-square foot retail center anchored by Home Depot and Target chain stores.
MR Beal & Co. will be the senior underwriter of the bonds, which will be enhanced with a letter of credit from ING Real Estate Finance, said Howard Klein, senior vice president of finance for Forest City Ratner. Fried, Frank, Harris, Shriver & Jacobson, LLP is bond counsel. Klein said it was impossible to determine the total cost of the garage at this point because it was tied into other aspects of the development. They expect to break ground on the project later this year.
The board also approved a controversial request for $12.5 million of civic facility revenue bonds for the All Stars Project, Inc, a nonprofit organization that serves more than 8,000 underprivileged youth with performing-arts activities and theater projects. The organization has been linked with Fred Newman and one-time Independence Party leader Lenora Fulani. Several Democratic politicians denounced Fulani and Newman as anti-Semitic, but IDA staff said the two appeared to be no longer connected to the organization's operations and that the IDA found no reason to deny tax-exempt financing.
"This was a case where the politics of destruction threatened to derail sound public policy, but the IDA made its decision on the merits, not the headlines," said Gabrielle L. Kurlander, president of the All Stars Project in a statement.
About $7.6 million of bonds would be used to refinance bonds issued in 2002 to purchase and renovate its facility on West 42nd Street, and about $4 million would be used to overhaul the HVAC system and facade. Roosevelt & Cross Inc. will underwrite the bonds, which will have a 30-year term to be issued in two series. JPMorgan will provide a letter of credit for the series A bonds.
The IDA also approved $9.9 million of revenue bonds for the Guttmacher Institute, a reproductive health think tank that seeks to move its headquarters from Wall Street to Maiden Lane in lower Manhattan. Guttmacher plans to use the proceeds of the sale, which will be underwritten by Roosevelt & Cross, to purchase a 25,611-square foot condominium unit. The institute hopes to close on the property in November.
The Gourmet Boutique, a Queens-based business that manufactures and distributes ready-to-eat meals, will get $6 million of bonds to consolidate two manufacturing locations.
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Myrtle Beach, S.C. Readies Sale for TIF District
Posted on Tuesday, September 26, 2006
Source: Bond Buyer
By Tedra DeSue
For 15 years, officials in Myrtle Beach, S.C., have worked to redevelop land occupied by an Air Force base closed under the 1990s Base Realignment and Closure Commission into a retail and residential area, and tomorrow their efforts will pay off when about $31 million of debt is sold for the undertaking.
Officials decided to make the former base a tax increment finance district, and the bonds sold tomorrow will be unrated TIF bonds. It is a limited offering, with Banc of America Securities LLC as the underwriter and the McNair Law Firm as the bond counsel. At the same time as the sale of the $31 million of Series 2006A debt, the city will also sell about $10 million of Series 200B bonds. The purchaser of those bonds will likely be the developers or an affiliated entity. The Series B bonds will be junior-lien debt.
During the early 1990s, the Myrtle Beach Air Force base was one of several throughout the country closed by BRAC. Officials wanted to transform the base and provide a boost to the economy. That led to plans that would allow the community to work and play in a concentrated area.
Plans call for several phases, including one that will include apartments built atop retail and commercial stores. A plethora of restaurants, as well as a grocer and a movie theater will round out this phase, scheduled to be completed by 2008.
Officials also want to bring on line additional residential space by 2012, and that housing will mainly include condos and town homes.
Observers point out that the risks of this type of financing account for the limited offering.
Banc of America Securities officials declined comment and Myrtle Beach representatives did not return phone calls by press time.
Many municipalities throughout the country have faced some criticism regarding issuing bonds that are backed by TIF dollars. That's because there is a risk that if the development doesn't spur the amount of revenues needed, the bonds would be at risk of default.
In the case of Myrtle Beach, it appears that the developers have made some headway in leasing out the development, which is key in these types of projects. For example, according to the limited offering statement, as of August, the developer had executed leases for about 58% of the total rentable space in one of the phases.
One market player also noted that has forced municipalities to more closely look at their projects and the amount of debt they issued. Prior to 2001, municipalities only had to get the approval of school districts and counties or other taxing entities if debt with maturities of more than 15 years would be issued. But a state law passed in 2001 requires cities to get the permission of these taxing entities for all tax increment debt regardless of maturity.
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IRS Releases Guidelines For Mixed-Use Facilities
Posted on Tuesday, September 26, 2006
Source: Bond Buyer
By Alison L. McConnell
After nearly a decade on the drawing board, the Internal Revenue Service today published proposed regulations that spell out how public-private partnerships are permissible in the context of municipal financing.
The regulations govern the use of tax-exempt bond proceeds for mixed-use facilities, and provide issuers with two elective methods of allocating bond proceeds across facilities that combine government and private business utilization.
Issuers and attorneys greeted the long-awaited allocation and accounting regulations with mixed reactions, noting that they were still working through the lengthy proposed rules. Still, they said the rules would provide issuers with flexibility in financing mixed-use projects.
"There's a lot there, and to really understand new regulations, you have to live with them for a period of time," said Bruce Serchuk of Nixon Peabody LLP here. "On an initial read, these are an excellent start."
Others pointed to the regulations' complexity.
"I guess if it takes nine years to draft, one should not expect to see regulations that are short and to the point," said Kutak Rock LLP's David Caprera. "But the 64 pages released today appear to have more detailed, tricky little rules and exceptions than one might think would be necessary for the vast majority of transactions which are impacted by these regulations."
The regulations are due to be published in the Federal Register today and are prospective, applying only to bonds issued 60 days after their pending finalization. The IRS is requesting comment and will hold a public hearing here in January before finalizing the rules.
"It's the last remaining big piece of guidance in the general private-activity bond regulations," said John J. Cross 3d, an attorney in the Treasury Department's tax legislative counsel's office. "It's a significant project in which we tried to address a lot of issues, and we expect there to be a lot of technical comments. We want people to take a good hard look at them and see if they work."
The proposed allocation and accounting regulations will be part of Section 141 of the federal tax code, which governs private-activity bonds. When the section was first written in 1997 the IRS said it would issue separate rules for allocation and accounting of bond proceeds, and in 2002 it said those rules were forthcoming. Since then, the regulations had been a top item on Treasury and the IRS' priority guidance plan.
"We've been waiting for a long time, and we're very glad that they're out," said Johanna Som de Cerff, senior technician reviewer in the IRS Office of Chief Counsel's tax-exempt bond branch. "We're looking forward to getting comments."
The federal tax code uses several private-activity "tests" to determine the amount of public and private benefit provided by facilities and projects financed with such bonds.
Under current rules, private entities may use no more than 10% of a tax-exempt bond-financed facility. The proposed regulations apply to "mixed-use" facilities that are reasonably expected to exceed that percentage over their lifetimes, financed by a combination of tax-exempt debt and "qualified equity," which can come from taxable bond proceeds or other funds.
Facilities are considered to be part of the same project if they demonstrate "reasonable nexus characteristics" such as functional and physical proximity, time of placement in service, and a common financing plan, according to the proposed rules.
They provide issuers with two elective methods of allocating tax-exempt bond proceeds to capital expenditures within mixed-use projects - the discrete physical portion allocation method and the undivided portion allocation method.
Under the first method, an issuer would have to divide its project into physically discrete portions - such as the floors of an office building - using a "reasonable, consistent" system and objective, proportionate benchmarks such as cost, space, or fair market value, the regulations said. Reallocations are allowed once every five years to address changes in private use.
The undivided portion allocation method, by contrast, involves a fixed percentage of private use based on objective, proportionate measures of benefit to be derived by various users. If an issuer elects to use that method of measurement, the percentage of private use cannot exceed the percentage of capital expenditure in the non-bond portion of total financing.
Issuers can choose one of the two elective methods only if governmental persons wholly own their mixed-use projects. The regulations provide one exception to that requirement, noting that the undivided portion allocation method can be used if undivided ownership interests in the facility are owned by governmental persons or private businesses, provided that they share the ownership, output, and operating expenses in proportion to their contributions to the costs of the facility.
Cross said Treasury and the IRS tried to do some innovative things, including encouraging issuers to take tax-exempt bonds off the market before a change of use occurs. The regulations contain an anticipatory redemption provision stipulating that issuers can treat certain proceeds of taxable bonds as qualified equity for purposes of retiring tax-exempt debt.
That theme may surprise people, because it is "beyond the classic idea of accounting rules," Cross said. "But it's related to the theme of targeting accounting to good and bad use when you can reasonably identify it and measure it. There's a lot of gory details as to how you do it, but that's the concept."
"I think issuers and 501(c)(3) organizations who find themselves in changed circumstances want to plan for remedial actions to their bonds, rather than waiting until it is a completed action," said Linda Schakel of Ballard Spahr Andrews & Ingersoll LLP here.
However, "there was some notion that the remedial actions were available only after the change was complete," and additional discussion about the provision would be welcome, Schakel added.
Both allocation methods are subject to an anti-abuse rule requiring use of "relative fair market values to measure the discrete portions when an allocation to a discrete portion expected to be used by a private business is significantly greater using relative fair market values than such allocation would be under the otherwise-chosen measure," the regulations said.
The IRS hopes to receive comment on that rule, and also said it is considering whether to allow an exception for government-private business partnerships with equal distributive shares of tax items such as deductions.
"The overemphasis on fair market value as the allocation medium may add complexity and uncertainty which is unwarranted," Caprera said. "It is often difficult to determine fair market value and there will be a practical concern in making its application."
Time is needed to fully comprehend the regulations, but they do not appear to contain any surprises, muni market participants said yesterday.
"These regulations are a giant step forward, and I can appreciate the time that went into them," Schakel said. "The legislative history from 1986 recognized that state and local governments and 501(c)(3) organizations should be permitted to finance mixed use facilities, but did not put meat on the bones of how to measure and account for the portion that would be eligible for tax-exempt bonds. These proposed regulations provide an excellent framework."
"The regulations expand on the potential advantages and pitfalls relating to post-issuance monitoring and record-keeping," said W. Mark Scott, a partner with Vinson & Elkins LLP here.
Taken as a whole, Caprera said that the regulations allow for reasonable mixed use of commonly financed facilities such as parking garages, research laboratories, and offices.
"The regulations appear consistent with the IRS rulings on naming rights and conservation easements; they are proposed with a prospective effective date; there will be public comment," he noted. "On the basis of these regulations, issuers, underwriters, and bond counsel should continue to ask for guidance and work with IRS and Treasury personnel with the expectation that we will all be in a better position through thoughtful, prospective rule-making than we are through retroactive IRS enforcement efforts."
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August 2006
Volume Off 24% From July 2005
Posted on Tuesday, August 01, 2006
By Michelle Kaske
Legislation: CDFA to Ask Congress to Expand IDB Manufacturing Definition
Posted on Tuesday, August 08, 2006
By Alison L. Mcconnell
N.Y.C. IDA To Weigh PILOTs Plan
Posted on Monday, July 31, 2006
By Robert Whalen
N.Y.C. Ballpark PILOTs Look, Act Like Taxes
Posted on Monday, August 07, 2006
By Robert Whalen and Adam L. Cataldo
Issuers Doing More CMS Deals
Posted on Wednesday, August 16, 2006
By Lynn Hume
Volume Off 24% From July 2005
Posted on Tuesday, August 01, 2006
Source: Bond Buyer
By Michelle Kaske
State and local governments sold about $26.05 billion of debt through 785 transactions last month as the volume of municipal bonds sold in 2006 continued to lag behind last year's record-setting pace.
Tax-exempt borrowers last month sold about 24% less debt than the $34.6 billion of debt issued during July 2005, according to Thomson Financial. Overall volume on a year-to-date basis is roughly $205.18 billion, down about 16% from the $244.44 billion sold during the same period last year, according to Thomson.
Refunding activity last month plummeted 84% to $1.6 billion from $10.3 billion in July 2005. So far this year, state and local government borrowers have refunded $37.46 billion, which compares with about $87.19 billion of refunding deals during the same period last year, Thomson data indicates.
Still, the persistent declines have been offset somewhat by new-money volume that has so far maintained a steady pace. New-money sales increased to $22.2 billion in July 2006 from $17.3 billion in the same month last year, a 28% increase. Overall, new money for 2006 is up nearly 15% to $143 billion from $124 billion in 2005.
"This is continuing the trend of issuance for the year where the new-money issuance continues at or slightly above last year's pace," said Peter DeGroot, a municipal bond strategist at Lehman Brothers. "But overall volume decreased based on the lack of refunding opportunities in the market due to the heavy refunding period in 2004 and 2005."
While the volume of refunding transactions increased annually from 2003 to 2005, new-money sales decreased during the same time. Now, new money has kept its strength while refunding has slowed down due to higher interest rates.
Yingchen Li, a municipal derivative strategist for Merrill Lynch & Co., said that even with July's lower numbers, the company believes that 2006 will meet the company's projected volume of $370 billion. And Thomas Doe, president of Municipal Market Advisors, is taking the July slump in stride.
"It's a year that's lighter in volume. So, this is just a continuation of the trend. July is historically lower than June," he said. Doe predicts that new-money and refunding sales combined for 2006 will reach $360 billion.
Analysts said it was hard to speculate when refunding volume might rebound, considering interest-rate uncertainty and that the market experienced heavy refunding in 2004 and 2005.
"There is considerable consternation with respect to near-term supply given the market's lack of conviction around the direction of interest rates and the Fed's current rate-hike campaign," DeGroot said.
The Florida Hurricane Catastrophe Fund and the Tennessee Energy Acquisition Corp. issued July's biggest sales at $2.8 billion and $1.9 billion, respectively. The Missouri Highwaysa and Transportation Commission had the third-largest sale, an $800 million offering.
Sales in the housing sector fared well, with last month showing a 25% increase, or $1.9 billion from $1.5 billion in July 2005. Housing has remained strong overall with a 35% increase in volume this year over last year's volume during the period - up to $17.5 billion from $12.9 billion.
July also added to a 44% increase in electric power bond sales for the year. Through the first seven months of 2005, sales totaled $5.7 billion, while this year, the total for electric power bonds sold is $8.3 billion.
Environmental facilities borrowing has cooled. Total sales so far this year were $2.7 billion, or 36% less than last year's figure of $4.3 billion. Last month's environmental facilities issues dropped by 45%, or $166 million, compared to July 2005.
The volume of educational bonds also indicate a decrease. This year's sales fell to $55.18 billion from $81.23 billion, a year-to-date decrease of roughly 32%.
But analysts remain optimistic even during this current atmosphere of decreased refunding sales.
"It's not dying, it's quite respectable considering how much interest rates have gone up," Li said.
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Legislation: CDFA to Ask Congress to Expand IDB Manufacturing Definition
Posted on Tuesday, August 08, 2006
Source: Bond Buyer
By Alison L. Mcconnell
The Council of Development Finance Agencies will focus next year on getting Congress to expand the definition of manufacturing for purposes of small-issue industrial development bonds, according to the group.
After securing a related legislative victory this spring, the CDFA hopes to use its voice on Capitol Hill to get the definition expanded. Manufacturing industries have evolved in the 30 years since the related tax laws were written, and new sectors such as biotechnology and software should be included as allowable projects for IDB financing, the group argues.
The CDFA, which outlined its upcoming legislative priorities in the latest edition of its newsletter yesterday, is a national organization that attempts to advance the interests of state and local governments and municipal authorities that provide economic development financing, including those using taxable and tax-exempt bonds, as well as several non-governmental and private organizations.
It notched a significant legislative victory in May when President Bush signed the tax reconciliation bill into law. That bill included a measure speeding up the effective date for an increase in the capital expenditure limit for small-issue industrial development bonds, from $10 million to $20 million.
The IDB increase was originally scheduled to go into effect Sept. 30, 2009, and the CDFA lobbied to move up its effective date after hearing that projects that were not going forward because small issuers were concerned about bumping up against the $10 million limit. The tax reconciliation bill provision moved the effective date to Dec. 31 of this year.
The CDFA regrouped after that win while development finance-related activity was slow on Capitol Hill, it said. Members of its legislative committee agreed that updating the definition of manufacturing for small-issue IDBs to include biotech, software, technology and other new economy manufactures is their most critical priority.
"To achieve this goal, CDFA staff and members will be making the rounds in Washington to build a partnership and consensus on the appropriate and renewed definition," the newsletter said.
The group also plans to connect with national muni groups such as the National Association of Bond Lawyers, the Government Finance Officers Association, and The Bond Market Association, which recently merged with the Securities Industry Association, "to build consensus on a new definition that all parties can support," it said.
Second on the priority list is securing an increase in the overall IDB size limitation, from $10 million to $20 million, which would allow more issuers access to financing and provide a stronger tool for the economic development community, according to the group.
"Much like the capital expenditure limitation, this limitation was established in the late 1970s and has not been adjusted for inflation over time. In today's economic terms, $10 million has only half the purchasing power that was available when the figure was determined," the CDFA said.
"Our two-year effort on [the capital expenditure increase] resulted in a positive change for the industry, and we hope to build on this success by working with Congress and other national partners to continue to improve the laws that govern industrial development bonds," executive director Toby Rittner added.
The CDFA said it would also continue monitoring the federal budget as it relates to federal funding and appropriations for financing programs, and keep an eye on efforts to curtail or limit the use of eminent domain for economic development as it relates to the use of tax increment financing and other special district finance tools.
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N.Y.C. IDA To Weigh PILOTs Plan
Posted on Monday, July 31, 2006
Source: Bond Buyer
By Robert Whalen
The New York City Industrial Development Agency on Friday released proposed amendments to its tax exemption program that will pave the way for up to $3 billion of PILOT debt to help finance a subway extension and redevelopment of the Hudson Yards area on Manhattan's Far West Side.
The proposed amendments establish a framework under which New York City can provide tax breaks and development incentives, including the use of tax-exempt debt backed by payments in lieu of taxes, or PILOTs. The IDA board is expected to vote on the matter Aug. 8 after holding a public hearing Thursday.
The amendments form the parameters of how the city - through the Hudson Yards Infrastructure Corp., which will sell the bonds - will administer tax breaks. The 60-acre Hudson Yards area, which extends from 32nd Street to 43rd Street, mostly between Eighth and 11th avenues, will be divided into three zones. Qualifying projects would be eligible for exemption from property, sales and use, and mortgage recording taxes.
The city wants to extend the No. 7 subway line westward from its Times Square terminal. Additionally, the redevelopment would include up to 24 million square feet of Class A office space, 13,500 residential units, 2 million square feet of hotel space, and parks and open space. City officials estimate the entire redevelopment will lead to the creation of 225,000 jobs by 2035.
The city's cost-benefit analysis estimates its PILOT incentives would cost $650.5 million in present dollars over the next 30 years. The IDA proposal indicates that officials expect the package of incentives would attract roughly $17.2 billion of private sector investment during that period.
City officials view tax breaks as essential components of the plans.
"Though Hudson Yards land prices are lower than those in the current Midtown business district, construction costs are the same, and Hudson Yards rents are expected to be substantially lower," according to the IDA proposal. "Under these circumstances, a building in Hudson Yards would not be able to achieve sufficient cash flow to justify the high cost of construction. Accordingly, the Agency financial assistance as proposed under the proposed UTEP amendment is necessary."
In addition to the tax-break incentives, the city will pay "on an annual by appropriation basis of interest on HYIC debt in any year in which all other HYIC revenues are insufficient to meet debt service requirements," the IDA document states.
New York City Mayor Michael Bloomberg has long advocated for the development of the Hudson Yards area; it was to be the site of a West Side stadium for the National Football League's Jets and the home of the 2012 Olympics. State lawmakers last year dashed the Jets stadium plans after the International Olympic Committee spiked the city's Olympic dreams.
Bloomberg spokeswoman Jennifer Falk said the administration was referring questions to the IDA. Authority officials deferred comment until the public hearings.
While the plan still needs some additional pieces to fall into place - such as the state Metropolitan Transportation Authority's acceptance of the city's more than $500 million offer to purchase development rights for a piece of MTA real estate - it has already secured support from the City Council, which last year approved rezoning the area for development. The city hopes to sell the first batch of HYIC debt sometime in the third quarter.
Many say that redeveloping the Hudson Yards is an important component in the city's overall push to expand its tax base and provide infrastructure from commercial and residential growth.
"It's important for the city to make sure it pursues the right set of infrastructure improvements," said Jeremy Soffin, vice president of public affairs at the Regional Plan Association. "We're looking to add one million people in the city and so you've got to think about where they're going to work and where they're going to live."
Soffin said that while some tax incentives may be necessary to get the overall redevelopment moving, he's concerned about the level of financial support the city is offering private developers.
"The concern is whether we're setting a precedent on the West Side that's going to limit the revenue that would otherwise come onto the city's tax roll in the next generation," he said.
Fiscal Policy Institute deputy director James Parrott said he generally supports the plan, but does not agree with the proposed financing method or the tax breaks at this point. The non-partisan Institute is hosting an open forum on the Hudson Yards project tomorrow, he said.
"There's no economic justification for giving the tax breaks years ahead of when the development is going to occur," he said. "The financing justification is that they have to do tax breaks now to get developers to sign the PILOT agreements. The only reason for the tax breaks is to establish a financing revenue stream. It's all premised on tax breaks, and we've been told the development will grow the tax base, but why again do we have to give away part of the tax base to expand the base?"
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N.Y.C. Ballpark PILOTs Look, Act Like Taxes
Posted on Monday, August 07, 2006
Source: Bond Buyer
By Robert Whalen and Adam L. Cataldo
By showing the Internal Revenue Service that payments paid by the professional baseball teams in lieu of city property taxes are not unlike the taxes that owners of similar properties pay, the New York City Industrial Development Agency won the IRS' approval for its planned structure to finance a pair of ballparks with up to $1.4 billion of tax-exempt debt.
The IDA in the coming weeks will sell bonds backed by payments in lieu of taxes, or PILOTs, to help the New York Mets and the New York Yankees finance new facilities in Queens and the Bronx. To insure that the transaction qualified as tax-exempt debt under federal law, IDA bond counsel Nixon Peabody LLP requested in January a pair of private-letter ruling from the IRS -- one for each transaction.
Cities typically use PILOT contracts to lure development, retain businesses, or collect revenue from otherwise exempt entities, such as governments, schools, and hospitals.
For economic activity purposes, cities usually take title to a parcel of land, which removes that real estate from its tax roll. It can then permit businesses to use the tax-exempt property in exchange for payments to the city that are lower than the property tax that would ordinarily be collected.
Here, the city is using PILOTs to help the Mets and Yankees pay for the new stadiums, so that the deals don't need direct support from taxpayers to repay the debt.
The 53,000-seat stadium planned for the Yankees is expected to cost about $1 billion, with about $866 million of the cost funded with PILOT debt. The Mets plan to sell about $528 million of tax-exempt PILOT debt for their 42,500-seat stadium, which is expected to cost about $800 million.
According to city figures, the Yankees will provide the IDA with about $55 million of PILOT revenue annually and the Mets will provide about $40 million of PILOTs each year. Additionally, the Yankees will pay about $5 million a year in rent, and the Mets will pay about $8 million. Rent payments will repay $104 million of taxable Mets debt and about $64 million of taxable Yankees debt.
Federal tax law permits issuers to back tax-exempt debt with PILOTs if certain standards are met. The tax code limits the use of tax-exempt bonds that benefit private entities. Because the ballparks would be used by the teams, which are private businesses, the bonds could not be tax-exempt debt if the money used to repay them came from a private entity.
Principally, the Nixon Peabody team needed to show: the project would serve a public purpose; the PILOTs would not exceed otherwise applicable property taxes; the PILOTs would be commensurate with such property taxes; and the PILOTs are not special charges the teams pay the city for use of the facilities.
Because attracting or retaining professional sports teams is considered a public purpose, and because the city has the ability to make sure the PILOTs are commensurate with and not in excess of otherwise applicable property taxes, the greatest challenge was to demonstrate that the PILOTs were not special charges.
With artful drafting by the lawyers working on the deal, the city and the teams were able to fit their PILOT agreements within the parameters of the IRS' tax-exemption requirements and not be considered an impermissible private payment.
"We had to structure the PILOT arrangements to look and act just like regular real property taxes in New York City," said Bruce Serchuk, a partner and tax specialist in Nixon Peabody's Washington, D.C., office.
Serchuk, who authored the requests for the private-letter rulings along with fellow partner and tax specialist Mitchell Rapaport, said the PILOT contracts had to simulate the city's tax statutes in order to stand up to IRS scrutiny.
"There's no doubt that these transactions are very complex, and the [IRS] put a lot of energy into understanding that complexity," Serchuk said. "The IRS went above and beyond the call in their efforts to learn, understand, and evaluate the transactions."
Due to its privacy policy, the IRS does not discuss its interaction with taxpayers. The IDA has not made the rulings available for review.
Citigroup Global Markets Inc. is underwriter on the Mets bond deal, which will be insured by Ambac Assurance Corp. Goldman, Sachs & Co. and Banc of America Securities LLC will underwrite the bonds for the Yankees, which will be backed by MBIA Insurance Corp. and Financial Guaranty Insurance Co.
Fulbright & Jaworski LLP is special counsel to the Mets and Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC is special counsel to the Yankees.
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Issuers Doing More CMS Deals
Posted on Wednesday, August 16, 2006
Source: Bond Buyer
By Lynn Hume
An increasing number of municipal issuers are entering into constant maturity swaps to lower their borrowing costs and create stronger interest rate hedges in the current flat yield curve environment where short-term rates are close to long-term rates, market participants said this week.
But while acknowledging the benefits of these swaps, Standard & Poor's issued a research report Monday that cautioned issuers to be cognizant of the fact that they can be more volatile than traditional basis swaps from a cash flow perspective.
The rating agency said issuers should not rely on these swaps to produce significant returns over the long term and should be prepared to restructure or terminate them if the yield curve becomes inverted, such that short-term rates are higher than long-term rates.
"Like other basis swaps, issuers should understand the potential volatility of the swap versus alternate structures and [should] have the management oversight necessary to quantify the range of cash-flow outcomes if the assumptions underlying the CMS structure were to deviate from expectations," the rating agency said in its one-page report. "Given the price volatility of CMS' relative to traditional basis swaps, the ability and willingness of the issuer to restructure or terminate the CMS should be considered and outlined in swap management plans."
A CMS is a variation of a traditional basis swap, or floating-to-floating-rate swap, in which the issuer exchanges a floating rate based on a short-term index, such as the London Interbank Offered Rate or the Bond Market Association municipal swap index, for a floating rate based on a longer-term rate such as five-year, seven-year, or 10-year Libor.
The term "constant maturity" is used because instead of receiving the variable leg at the shortest point of the yield curve, one can pick a different point on the yield curve, a constant maturity, and that will be the point at which the variable leg will be calculated.
These swaps have been used for some time in the taxable bond market, but are increasingly being used in the tax-exempt bond market, sources said. In the current flat yield curve environment, issuers are using CMS' to restructure existing swaps or to add new basis swaps on different points of the yield curve at less cost than would be possible in a more "normal," sloping yield curve environment, where long-term rates are higher.
A CMS allows the issuer to move the floating receipt leg of a basis swap further out on the yield curve than would have been economically possible with a normally steep yield curve. The issuer is anticipating a yield curve correction will occur so that the spread between short-term and long-term rates widens. By receiving a variable payment based on a longer-term rate, an issuer would benefit from the positive cash flows that would result from a steeper yield curve.
Nat Singer, a senior managing director and manager at Bear, Stearns & Co., said yesterday that these kinds of swaps can provide significant benefits for issuers that do swaps in the municipal market.
"Generally, my view is that for a larger issuer that has a portfolio of swaps, it's an interesting diversification play and it's also an interesting hedge for some of the risks in the existing portfolio," he said.
For example, Singer said Libor-based swaps tend to under-perform when the Federal Reserve Board eases and short-term rates drop very low, while CMS' tend to out-perform in such scenarios and serve as an offset to the Libor risk. "That's just one example," he said.
But the Standard & Poor's report pointed out that if the yield curve flattens again or becomes inverted, issuers would receive significantly diminished returns or would have to begin making net payments to the counterparty under a CMS.
"We've seen a flurry of these in all sectors because long-term rates essentially are for sale, and to the extent you can get additional revenue at no or little cost at relatively low risk, it's probably a good thing to do if you understand" what you're getting involved in, said Peter Block, a director at Standard & Poor's in Chicago.
"You have to recognize there is higher volatility from these than traditional basis swaps. The variability of returns is higher on CMS' because the trading range of one month Libor to a five-year Libor is potentially very wide, depending on the steepness of the yield curve and how quickly the curve steepens."
"If the yield curve is flat, you may break even or may show slightly negative returns. The real risk is if the yield curve inverts for a prolonged period of time, the issuer becomes a net payer when it thought it was going to make all of this money," Block said.
"We're just cautioning issuers against budgeting too much of the potential positive returns off these swaps because we know, based on historical data, that the yield curve should go back to an upward sloping," he said.
Standard & Poor's stressed in its research report that, to date, CMS structures have not altered the debt derivative profile scores or ratings of any issuers.
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July 2006
First-Half Issuance Declines Nearly 15%
Posted on Monday, July 03, 2006
By Michelle Kaske
Bond Counsel: Re-Branded Peck Shaffer Aims to Remain a Player in Muni Market
Posted on Tuesday, July 11, 2006
By Tedra Desue
Housing: With Fannie Mae in Holding Pattern, Other Buyers Fill the Void
Posted on Friday, July 21, 2006
By Jacob Fine
Florida Firm to Use Tax-Exempt Bonds For Financing Special Treatment Facility
Posted on Thursday, July 20, 2006
By Shelly Sigo
Chicago-Based LaSalle to Sell Muni Trustee Business Before End of Year
Posted on Wednesday, July 26, 2006
By Yvette Shields
First-Half Issuance Declines Nearly 15%
Posted on Monday, July 03, 2006
Source: Bond Buyer
By Michelle Kaske
Municipal bond volume was 14.6% lower during the first half of this year compared with 2005, making it the slowest six-month start in four years, with issuance totaling $179.26 billion, according to preliminary statistics released last week by Thomson Financial.
For the month just ended, however, bond volume was off less than 1% from last year's levels, with issuers selling $43.82 billion in long-term debt through 1,231 issues, compared with $44.23 billion via 1,523 issues in June 2005.
Refunding bond sales dropped more than 52.3% to $36.7 billion through the end of June, from roughly $76.86 billion in the first half of 2005. With increased interest rates, state and local government borrowers are becoming less likely to seek refundings.
New-money borrowing, however, was up 15.4%, to nearly $123.97 billion through 4,346 issues, from $107.43 billion in 4,360 issues during the year-earlier period.
According to Gary Strumeyer, head trader for the Bank of New York Co., the trend was only natural. "As rates rise, you see less refinancing reissuance," he said.
The Federal Open Market Committee last week continued its efforts to control inflation, raising the overnight lending rate 25 basis points to 5.25% -- the 17th consecutive increase since June 2004.
So far this year, muni market rates have been rising as well. The rate on The Bond Buyer's 20-bond general obligation index has ranged as high as 4.71% last week from a low of 4.33% on Jan. 19.
The rising rates have also affected issuance in the short-term market. Short-term note financing also declined, as states in general are experiencing healthier budgets with less need to borrow for liquidity, sources said. Overall note issuance for the first half was $16.124 billion, the lowest it has been since the first six months of 1989, when $15.325 billion was sold. Last month's note issuance was $8.409 billion, the lowest since June 1999, when $8.095 billion was sold.
Citing improved budget balancing and increased revenue from state taxes and rising real estate taxes to pull from, analysts said the majority of state governments are not in a cash crunch.
"The states are in such vastly improved financial condition compared to just three years ago," said Chris Mier, a Loop Capital Markets LLC analyst.
Higher interest rates were also a factor for note financing as states are less inclined to issue notes now that the cost of borrowing has increased.
Another factor for the trend of decreasing volume is the types of bonds that are not dominating the market. "It's sort of interesting what's not occurring this year," Mier said. There have been fewer "mega deals" such as large tobacco, state deficit, or pension obligation bonds to increase overall volume, he said.
June was the strongest month of 2006, with bond sales of more than $43 billion, although that number is 0.9% less than the same month last year.
The electric power and housing bond sectors are the areas up from the first half of last year, with increases of 40.8% and 34%, respectively.
Florida's Citizens Property Insurance Corp. was June's biggest issuer, with a $3.05 billion sale. The deal, combined with the Florida Hurricane Catastrophe Fund's $1.35 billion sale, also last month, helped push Florida to third busiest for the first half. Sunshine State issuers sold almost $13.72 billion through 195 issues, ahead of New York, where issuers sold $13.49 billion in bonds through 340 issues during the six-month period.
California, led by the state's $1.012 billion GO sale last month, was the busiest state for issuance, with some $23.99 billion in debt coming to market from issuers there through 468 sales. Texas was second with issuers there selling $17.08 billion through 476 issues.
Even with the drop in volume, experts are not worried about the lending market. Mier said he wasn't put off by the first-half figures in comparison with years past. "It still looks pretty large in the grand scheme of things," he said.
Overall, the volume of bonds sold in the first half of 2006 was more than the amount sold in all of 1995. If issuance continues at this pace, volume for the year could be close to the $358.58 billion and $360.02 billion issued in 2002 and 2004, respectively.
Some of June's growth this year came in the taxable debt sector, where issuance was up 43% from June 2005. A total of $5.63 billion in taxable debt came to market in 113 issues, compared with $3.94 billion in 92 issues a year earlier. That activity contributed to the more than 20% growth in taxable issuance for the year to date. In 2006, issues have sold $14.34 billion in 423 issues, up from $11.87 billion in 417 issues in 2005.
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Bond Counsel: Re-Branded Peck Shaffer Aims to Remain a Player in Muni Market
Posted on Tuesday, July 11, 2006
Source: Bond Buyer
By Tedra Desue
For 117 years, Peck Shaffer has contributed to the municipal bond industry by serving as underwriters' or bond counsel on scores of transactions, and over the past year the firm has gone through a re-branding effort designed to position it for the years ahead.
Several issuers throughout the country, including those in Hamilton County, Ohio, where the firm has been bond counsel for more than 100 years, have applauded its performance. In fact, its roots are embedded in Hamilton's county seat, Cincinnati, and Peck Shaffer attorneys credit the firm's work in the city with helping it to expand nationally.
Now the firm has offices in other parts of the country, including in Atlanta, Chicago, and Denver. There are offices also in Covington and Louisville in Kentucky and in Columbus, Ohio. There are 40 attorneys working for the firm.
Partner John Merchant said the branding effort is designed to further solidify their position in the market. The effort has entailed a new logo, as well as updating its technology. A new Web site was developed and the firm officially announced it would go by Peck Shaffer while still retaining its full legal name of Peck, Shaffer & Williams LLP.
"Due to the firm's expansion and growth, it was time for the firm to experience a face lift and develop a strong message," Merchant said. "While the firm's look has changed and the message is stronger, we have taken great effort to preserve the personal service that our clients have grown to enjoy."
One of the things the attorneys take pride in is not having billable hours. Instead of such a pay structure, clients are given upfront cost amounts, explained managing partner Doloris Learmonth.
"We call it value billing. We figure out the cost of a project ahead of time and that allows for some flexibility," Learmonth said. "The meter isn't running."
Clients like Karen McFarland, the debt manager for Hamilton County, said that's one of the things they like about the firm. But the personal attention the attorneys provide for its transactions is just as invaluable, she said. She noted that the long history between Peck Shaffer and the county provide the county with somewhat of an edge over the firm's competition as the attorneys have extensive knowledge of the county's previous transactions. McFarland said that the main reason her government chose to continue to deal with the firm is its proven track record.
On the horizon are several deals that Peck Shaffer will serve as bond counsel for Hamilton County. One of those is a roughly $24 million transaction and proceeds will be used to make improvements to the water and sewer system.
McFarland recalled two other deals that exemplified what she called a "superb job" by the firm's attorneys. They were for the football stadium for the National Football League's Cincinnati Bengals and the ballpark for Major League Baseball's Cincinnati Reds.
Attorney John Fischer also recalled the stadium deals as being two of the most memorable on which he's served as bond counsel. For one thing, the deal involved using sales tax revenues to back the bonds, which was not common at that time.
"For that deal, we had to get sales-tax backed bonds approved, and get the law amended to allow for the financing," Fischer said.
The football stadium financing was $270 million and the baseball stadium's was $350 million.
Peck Shaffer has also been active in Kentucky, and currently is bond counsel for several of the state's issuers, including the Kentucky State Property and Buildings Commission and the University of Kentucky. Terri Fugate, the deputy executive director for the state's Office of Financial Management, explained that market players, such as law firms, must go through a rigorous selection process as required by the state's statutes.
Currently she said Peck Shaffer is helping to update the bond indentures for the state's nine universities.
One of the firm's attorneys, Susan Pease Langford, left the city of Atlanta as an attorney to work for Peck Shaffer. She joined the Atlanta office in 2001 and works there with Jerry Peterson and David Williams.
She just wrapped up a roughly $44 million student housing transaction for Fort Valley State University in Georgia. The Peach County Development Authority sold the bonds. Peck Shaffer served as borrower's counsel and bond counsel.
"With the Fort Valley transaction, I was really able to provide some assistance," Langford said. "I felt like I made a difference."
One of the reasons Learmonth said the firm has been successful in building relationships in the community is because of the experience and caliber of the attorneys. Several of them have been with Peck Shaffer for more than 25 years, including Learmonth, and partners Thomas Luebbers, John Fischer, and John Peck.
Peck is credited with helping to develop the first tax-exempt multifamily housing deal during the 1970s.
Considering the housing turmoil plaguing the Gulf Coast states because of last year's hurricanes, Peck said he was naturally interested in assisting issuers there with housing deals. In fact, he recently completed an $8 million housing deal sold by the Louisiana Public Facilities Authority.
From his office in the heart of Atlanta's financial district last month, attorney Jerry Peterson gazes out of the window and is clearly content with being a part of the firm.
"You feel like you're financing projects for the good of the community," Peterson said, recalling his work on a bond transaction for the world-renowned Shepherd Spinal Center in Atlanta.
Learmonth agreed, adding: "I've found my true calling. I'm helping in all sorts of ways and getting to meet some of the most interesting people as I do."
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Housing: With Fannie Mae in Holding Pattern, Other Buyers Fill the Void
Posted on Friday, July 21, 2006
Source: Bond Buyer
By Jacob Fine
New buyers have stepped in to help take the place of Fannie Mae as a source of demand amid this year's skyrocketing municipal housing bond issuance as the mortgage market titan's portfolio remains under a regulatory freeze, according to analysts.
In May, Fannie Mae entered a consent agreement with the Office of Federal Housing Enterprise Oversight to keep its mortgage portfolio at a level of $727 billion due to a lack of internal controls after it was found to have manipulated accounting rules to maximize bonuses for senior executives.
Fannie Mae had already stopped buying the securities a year earlier after bumping up against a tax rule. Muni bonds had grown to 2% of Fannie Mae's overall portfolio, above which it would have to prove to the Treasury that it was not buying the securities to write off its cost of borrowing.
While Fannie may be allowed a moderate yearly increase in its portfolio assets under the recent consent agreement, OFHEO director James Lockhart in May said the limitation could be in place for years.
Initially, the giant mortgage provider's pullback from the market in 2005 was a cause of concern in the municipal housing market, and there were some early indications of spread widening, according to Kurt van Kuller, director of municipal credit research at Merrill Lynch & Co. in New York.
According to van Kuller, the municipal housing market had become much more dependent on government sponsored enterprises in recent years, and Fannie Mae in particular. Demand from other types of investors had diminished during the early part of this decade as many single-family mortgage revenue bonds were unable to keep up with the broader bond market rally because of their heightened call risk as many homeowners took advantage of low mortgage rates to refinance. Because most single-family term bonds are callable at par, the price appreciation they can experience is typically very limited, according to van Kuller.
In addition to the absence of Fannie Mae, another factor had begun to cause concern in the municipal housing market earlier this year -- mounting supply.
Municipal housing issuance was up a startling 35% during the first half of 2006 as issuers sold a record $12.42 billion in single-family bonds, according to Thomson Financial. Previously, the most single-family muni bonds sold by state and local government housing finance authorities during the first half of a year was just $7.58 billion in 1992.
As the rates that local banks charge for 30-year mortgages have risen by more than 130 basis points since 2003, more people have been turning to the affordability assistance that single-family mortgage bond programs provide, according to van Kuller.
"State HFAs are experiencing unprecedented origination volume," he wrote in a report on the phenomenon this week. "This pace, if maintained, would shatter annual totals," he added.
As issuance has surged, housing bonds have traded off some, according to traders. But other buyers that have emerged to take the place of Fannie Mae have helped to support the market, according to van Kuller.
"The sector is back in favor, strongly," van Kuller said in an interview this week. "Many, many new investors have come into the market in the last year or year and a half."
Those buyers include traditional mutual funds that had shied away from housing bonds in favor of other stronger performing sectors during the bond market rally, in addition to high-yield mutual funds, hedge funds, and other arbitrageurs drawn to mortgage revenue bonds for the relatively high yields they offer.
"The market is looking at historic narrows in credit spreads and triple-B's are trading at about 5%," van Kuller said yesterday. "You have housing bonds at 5.15% or so for a new issue 30-year long-end bond with double-A and triple-A ratings, and its very attractive for yield."
"They're expected to outperform because interest rates are expected to be flat to mildly rising and since yield in that environment will be the main determinant of outperformance you want bonds like housing bonds because they offer a little more yield and yield is king in this market," he added.
Michael Petty, a senior portfolio manager at The Dreyfus Corp. in New York, said the firm's mutual funds have been buyers of muni housing bonds recently based on their interest rate outlook and the yields that the securities offer.
According to Petty, the absence of Fannie Mae has helped other investors get better access. "They would be willing to pay five or ten basis points through current market levels to get a whole term bond in an issue, so it took a lot of the supply that could have gone to the market sort of out of play," he said.
In addition to mutual funds, tender option bond programs have also become a source of demand for the paper, Petty noted.
Housing bonds offer higher yields to compensate investors for some drawbacks. The bonds are prone to a higher degree of call risk, which creates some uncertainty over their average life or duration, and many are also subject to the alternative minimum tax.
However, van Kuller said those that are highly rated make sense for all types of accounts, including retail. "Frankly, I don't know another sector that we would recommend more in terms of what to buy now," he said.
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Florida Firm to Use Tax-Exempt Bonds For Financing Special Treatment Facility
Posted on Thursday, July 20, 2006
Source: Bond Buyer
By Shelly Sigo
In the first public-private partnership of its kind in Florida, a state agency has inked a deal with a company to build and operate a state-of-the-art treatment facility financed with tax-exempt debt called the Florida Civil Commitment Center for sexually violent predators.
Boca Raton, Fla.-based GEO Group Inc., formerly known as the Wackenhut Corrections Corp., announced July 3 that it had received a contract from Florida's Department of Children and Families, or DCF, to manage and operate an existing 545-bed facility in Arcadia, and to begin construction of a new $60 million, 660-bed replacement facility to be financed with tax-exempt bonds.
The total bond issue, expected to sell in November, will be about $62 million, including about $1.2 million for costs of issuance, said DCF spokesman Tim Bottcher.
"The bonds will be issued by a 501(c)3 corporation established for this purpose," Bottcher said. "It will likely be named the Florida Civil Commitment Center Financing Corp."
GEO Group will assume operation of the new facility upon its completion in 2008 under the terms of the operations contract, the company said. The new facility will be leased to and ultimately owned by the state.
The structure of the deal is expected to be similar to the one used by Florida school boards, using a nonprofit corporation to create the leasing structure, and it may involve using certificates of participation, said Garry Johnson, a director at Tripp Scott PA, which is bond counsel on the deal.
"On these deals, it's not a master lease like the schools use, it is a singular lease," said Johnson, who worked on another transaction with the Department of Children and Families to build an evaluation and treatment center. "The lease is a capital lease and the department obligates itself to pay the lease."
The Florida Civil Commitment Center is an outgrowth of the Jimmy Ryce Involuntary Civil Commitment for Sexually Violent Predators' Treatment and Care Act.
The law was passed by the Florida Legislature in 1998 and signed into law by then-Gov. Lawton Chiles. It is named for 9-year-old Jimmy Ryce, who was kidnapped from his school bus stop in south Florida on Sept. 11, 1995, then raped and shot to death. Juan Chavez, who was convicted of Jimmy's murder, remains on death row.
The act creates the Sexually Violent Predator Program in which a person convicted of a sexually violent offense can be involuntarily placed in the Civil Commitment Center upon release from prison.
More than 15 states have enacted legislation similar to Florida's Jimmy Ryce act, but it is not clear how many have used tax-exempt debt to build specialized facilities for sexually violent predators.
The financial adviser on Florida's deal will be Marianne Edmonds with Public Resources Advisory Group.
Banc of America Securities LLC will be the underwriter. GrayRobinson PA will be underwriters' counsel.
The Florida Legislature appropriated $26 million in general revenue in fiscal 2006 for the Sexually Violent Predator Program, which is operated under the Mental Health Program Office by DCF.
Florida has six mental health treatment facilities for adults statewide. Three are operated by DCF and three are operated by private vendors. Three facilities serve civilly committed persons, two serve forensically committed persons, and the Arcadia facility is reserved for sexually violent predators.
GEO also manages the South Florida State Hospital in Pembroke Pines, a 325-bed facility for severely and persistently mentally ill adults, which it designed, constructed, and financed on state-owned property. The facility opened in December 2000 as the only new state civil psychiatric hospital built in the state in the last 40 years, the company said.
Last year, DCF selected GEO to manage and operate the existing 200-bed South Florida Evaluation and Treatment Center and to build and operate a new 200-bed replacement facility in Miami. The center is a secure forensic psychiatric hospital for patients deemed by a judge to need psychiatric services before continuing in the judicial process. It is the first privately managed forensic psychiatric facility in the United States, GEO said.
Health care services are part of GEO's planned program for diversification into businesses related to core services, according to the company's Web site.
GEO is one of the largest operators of detention and prison facilities in the United States, Canada, South Africa, and Australia. In the U.S., many of those are immigration detention services that are growing as the federal government toughens enforcement of illegal immigration laws.
Many of the detention facilities in the U.S. are built with tax-exempt bonds issued through industrial development boards or special nonprofit entities.
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Chicago-Based LaSalle to Sell Muni Trustee Business Before End of Year
Posted on Wednesday, July 26, 2006
Source: Bond Buyer
By Yvette Shields
LaSalle Bank Corp. announced internally yesterday it intends to sell its Municipal Trustee Business before year's end after deciding the line is "outside of LaSalle's core focus area," according to a statement from the Chicago-based bank that is part of the Dutch-owned ABN AMRO network.
Municipal trust services are included under the umbrella of the Global Securities and Trust Services business unit, which includes the bank's broader Corporate Trust Group and other lines marketed to the structured financial markets, including Shareholder Services, Chicago Deferred Exchange Corp., Escrow Services, and Project Finance.
The firm remains "strongly committed" to the GSTS products that will remain and believes the sale of the municipal portfolio "will allow the bank to strengthen its capabilities" in those remaining areas.
"We are confident that both LaSalle and our GSTS client base will be better served by the decision to sell our Municipal Trustee Business," the GSTS group senior vice president Russell Goldenberg said in a statement. "The interests of our municipal clients will be considered at every juncture of the sale process."
The company declined to comment on potential buyers or whether negotiations were underway with any firms interested in the portfolio. The bank also could not immediately provide any information on the revenues generated by the municipal line.
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June 2006
N.J. EDA Chief Cites Plan To Boost State's Economy
Posted on Thursday, June 22, 2006
By Adam L. Cataldo
Understanding Counterparty Risk
Posted on Monday, June 26, 2006
By TBMA's Municipal Financial Products Committee
TBMA and SIA Vote to Merge for More Clout
Posted on Thursday, June 29, 2006
By Lynn Hume
Private-Activity: Bonds New Bill Would Allow Tribal Issuance, But Not for Casinos
Posted on Thursday, June 29, 2006
By Alison L. Mcconnell
SEC: It's Lawyers' Duty to Dig
Posted on Friday, June 30, 2006
By Lynn Hume
N.J. EDA Chief Cites Plan To Boost State's Economy
Posted on Thursday, June 22, 2006
Source: Bond Buyer
By Adam L. Cataldo
The New Jersey Economic Development Authority chief said yesterday that state officials are working on a plan to develop and grow the state's economy.
NJEDA executive director Caren Franzini mentioned the plan during a luncheon speech to the Municipal Forum of New York at the Union League Club in Manhattan.
Speaking afterwards, Franzini said she expects the EDA to implement the new policies within its traditional role of providing financial aid to businesses looking to grow within the state.
Franzini said in her speech that under new Gov. Jon Corzine, the EDA now has a more open and visible role within the state.
"Gov. Corzine came in with a new agenda, an agenda focused on the economy," Franzini said. "I think it's critical that we focus on the economy as the way to get out of our budget [gap] and the only way to get out of our budget [gap] is to have recurring growing the economy."
Corzine is negotiating the details of his proposed $30.9 billion spending plan with lawmakers. While he proposes increasing the sales tax to 7% from 6% to help close a multi-billion budget gap, Corzine has said he wants the state to return to fiscal stability by growing the economy.
Franzini said that to do that, Corzine established the Office of Economic Growth. It is headed by Gary Rose, a former colleague of Corzine's at Goldman, Sachs & Co. That office is located within the office of the governor. A call to the office for comment yesterday was not returned.
"Their goal is to create an economic strategy with the governor for the state," Franzini said. "We don't have a plan in terms of how we should be growing the economy, what is our goal, and how we could get there."
Franzini said Corzine has been working on a plan over the last couple of months with Rose and his office and will continue to do so over the summer.
Franzini said New Jersey does not have a lot of capital to invest, and that most of it spread among different groups, such as the Transportation Trust Fund Authority.
"What the strategic plan will help do is help direct all of us because we have to make sure that we invest our resources as public entities, to make sure that we are going to get the best bang for our buck and bring business and growth ... to the state," she said.
The EDA is a state-level conduit issuer that helps arrange financing for businesses, with an emphasis on small- to mid-sized firms and nonprofits in the state. The EDA's mission it to create jobs and spur economic activity.
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Understanding Counterparty Risk
Posted on Monday, June 26, 2006
Source: Bond Buyer
By TBMA's Municipal Financial Products Committee
Interest rate swaps create an exposure that may be unique for many municipalities: long-term credit exposure to their swap counterparty, typically a financial institution. Municipalities must fully understand the nature of that exposure and carefully consider the various tools that are available to mitigate the risk from their counterparty defaulting under the swap. Well-developed credit policies, proper analysis of the exposure, use of industry-standard documentation, and requirements for collateral are proven and effective ways to manage that risk.
In its simplest form, counterparty risk is the potential loss of value due to default -- i.e., failure to make payments -- by a swap counterparty. To frame the discussion, we explore the two key components: 1) the likelihood that a counterparty will default, and 2) the potential severity of the loss that may result.
The probability of a counterparty default is low in the municipal derivatives market, particularly when viewed from the standpoint of the municipality. Municipal derivatives end users almost exclusively enter into transactions with highly rated swap dealers. Swap statutes, policies, and market practice generally limit municipalities to entering into contracts with dealers rated in the high investment-grade categories, with double-A and triple-A category dealers dominating the landscape. A smaller component of the market is executed with single-A rated dealers, generally under a collateralized arrangement. (We will discuss collateral later, under risk mitigation.) In the last two decades, there is scant evidence of derivatives contract defaults by dealers in these rating categories. While interest rate swap transactions are not subject to federal regulation, those financial institutions that enter into transactions are generally highly regulated and undergo intense scrutiny to monitor their financial health.
While it may be true that the risk of default by a dealer for a swap contract is remote, it is still quite important to measure the risk of loss in case that remote event occurs. A measurement indicator used by municipalities is notional amount. This measure does not accurately quantify potential loss. Swap agreements are only "denominated" in notional amount for a single purpose -- to calculate a set of cash flows that each party agrees to pay the other party over the life of the agreement. Notional amounts are never owed from one party to another. The only obligations that either party bears are the ongoing cash flows that result from the multiplication of a notional amount by a fixed rate or an index.
In a typical transaction, the municipal counterparty may agree to make a series of fixed payments that are calculated by multiplying a fixed interest rate -- 4.5%, for example -- by a notional amount. In exchange, the dealer agrees to pay the counterparty a series of floating payments determined by multiplying the same notional amount by a variable-rate index, i.e., the one-month London Interbank Offered Rate. This allows the municipality to convert an underlying obligation to a "net" fixed rate. These contract payments may be created for a month, a year, or decades. Since each party is agreeing to exchange a set of cash flows with the other, both parties have the potential to default. The risk is bilateral.
Swap contracts are generally valueless at their inception. They are based upon then-prevailing rates, or indexes. However, each time market rates increase or decrease, the value of the contract changes, up or down. For our prior example, a floating-to-fixed rate swap, the value of the contract is generally determined by changes in market rates for fixed payments. Much like a fixed-rate bond, the changes to the contract value represent how much of a discount or premium is required to create a contract that is fairly valued by then-prevailing market conditions.
For example, let's assume a municipal counterparty entered into a $100 million notional amount floating-to-fixed rate swap at a 4.5% rate for twenty years. Further assume that the 4.5% rate was a fair market rate at the time of execution. One year later, rates move to 5.5%. That municipality is still paying 4.5%, one percentage point below then-prevailing market rates. If the municipality's swap dealer were to default, the municipality would be forced to try to replace the original contract, but would have to pay another dealer 5.5%, the current market rate. To entice the replacement dealer to accept a 4.5% below-market rate, it would have to include an up-front payment that, when bundled with the 4.5% rate, would be the economic equivalent rate of a 5.5% swap rate. That extra amount is the present value of the difference between the cash flows of a 5.5% obligation less a 4.5% obligation. In our example, this payment may be approximately $10.5 million. This is equivalent to the mark-to-market value of the swap. (Note that there are standard market conventions for calculating this mark-to-market value amount.) It is only this mark-to-market amount that is the true measure of loss sustained by the municipality, if they are not able to recoup the amount from their defaulting swap dealer.
The current mark-to-market value measures immediate loss, but does not take into account the potential magnitude of future losses. Although it is possible to shortcut this estimate by shifting yield curves up and down by one, two, or three percentage points and then calculating a matrix of potential mark-to-market values, this method has shortfalls in that it applies no sense of probability to those future interest rate scenarios. How likely are rates to move up or down by those amounts? Dealers use models that do account for a probability-adjusted view of future rates, much like those models used to price interest rate options, that employ either historical or "market traded" views of rate variability to create a more refined outlook.
Generally speaking, the range of values for a swap contract narrows as it ages, due to the smaller number of remaining cash flow payments owed by each party. However, this fact is juxtaposed against the greater uncertainty of interest rates the longer out in the future we look. Putting the two together, we observe that credit risk is generally at a peak somewhere in the middle years of the contract.
A municipal obligor may have multiple swaps between itself and a dealer. Certain of these swaps may be in offsetting directions (i.e., floating-to-fixed and fixed-to-floating). Since standard ISDA contract provisions outline that a default under one swap causes all swaps under the same contract to be terminated at the same time, credit risk should be measured for the entire portfolio of swaps under the same ISDA Master Agreement. Consequently, there is a risk reduction benefit for municipalities to consolidate activity with a single dealer when swaps act in opposite directions.
For example, take the case of a municipal obligor that has entered into two swaps, a $25 million floating-to-fixed swap and a $15 million fixed-to-floating swap. If the swaps were transacted with a single dealer, the municipality's credit exposure to the dealer would be measured as the net mark-to-market value of the two swaps. Since they go in opposite directions, a move upward in fixed rates will cause the floating-to-fixed swap value to increase, while the fixed-to-floating swap will simultaneously decrease. When the changes are added together, the total swap portfolio value will move less than either individual swap, dampening the overall credit risk volatility. If the swaps were transacted with two dealers, the overall interest rate risk would be the same, but exposure to individual credit risk, now, and in the future, would be higher.
Finally, many swap agreements provide for a counterparty to be obligated to post collateral to the other counterparty when the aggregate credit exposure of the swap portfolio under an agreement exceeds certain threshold amounts -- $10 million, for example. The amount of collateral that is required is generally equal to the current mark-to-market of the portfolio that exceeds the threshold amount. Collateral and mark-to-market values are calculated frequently to mitigate the potential for unexpected losses. Thus, the true unsecured credit exposure is limited to the threshold amount. Threshold amounts often vary by the credit ratings of the counterparty at the time that it is required to post the collateral. Most often, the threshold amount is higher for counterparties with higher credit ratings. It is interesting to note that when all swap counterparty exposure is consolidated with a single dealer, counterparty risk might be mitigated.
For example, assume that the municipal counterparty enters into three floating-to-fixed rate swaps with different dealers and that each has a current mark-to-market value to the municipality of $8 million, or $24 million overall. Using the threshold amount of $10 million shown above, no single dealer would be required to deliver collateral because no single dealer credit risk exceeds the $10 million. If all three swaps are with a single dealer, the dealer would be delivering $14 million of collateral -- the $24 million of total mark-to-market credit exposure less the $10 million threshold. Consequently, the municipality benefits from $14 million of security it would not get if three dealers were involved.
In sum, when entering into derivatives contracts, municipal counterparties should consider the following methods for managing and mitigating counterparty risk: Execute transactions with highly rated counterparties, measure and monitor worst case mark-to-market scenarios, and employ industry-standard credit mechanisms that include collateral posting and portfolio netting. Historically, actual credit losses in the swap market have been very low, and a wide variety of tools are available to counterparties to ensure low probability of loss in the future.
This is the second article by The Bond Market Association's Municipal Financial Products Committee. The committee is writing commentary to enhance the understanding and awareness of derivatives as a financial risk management tool. The committee consists principally of dealers in the market for derivatives in which the end-user is a borrower of the proceeds or an issuer of tax-exempt debt (e.g., U.S. governments and nonprofits). The Bond Market Association represents securities firms, banks, and asset managers that underwrite, invest, trade, and sell debt securities and other financial products globally.
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TBMA and SIA Vote to Merge for More Clout
Posted on Thursday, June 29, 2006
Source: Bond Buyer
By Lynn Hume
The separate 31-member boards of The Bond Market Association and the Securities Industry Association voted yesterday to merge the two groups to create the Securities Industry and Financial Markets Association, or SIFMA -- a combination designed to create a more powerful voice in the legislative and regulatory arenas as well as the financial markets.
The merger, however, must still be approved by member firms of the two groups on July 27.
The new group will be based in both New York City, where TBMA's headquarters offices are, and Washington, D.C., where the SIA is based, officials of the two groups said today during a press briefing.
SIFMA will be co-chaired by Edward C. Forst, chief administrative officer of the Goldman Sachs Group and the chair of TBMA, and James P. Gorman, president and chief operating officer of the Global Wealth Management Group at Morgan Stanley, and the chair of SIA, through the end of the year.
The new organization's board will be slightly larger than either of the two groups, at between 32 and 35 members and will represent a range of firms, Forst said.
Micah S. Green, TBMA's president, and Marc E. Lackritz, the SIA's president, will serve as co-chief executive officers of SIFMA, but the boards are currently examining other candidates outside of the two organizations, as well as Green and Lackritz, for SIFMA's top staff position, Forst said.
The two groups are expected to merge their political action committees. They plan to keep dues for member firms at the same level for the next year, but see reductions in those dues in subsequent years.
The merger effectively recombines two groups that, historically, were once both part of the Securities Industry Association and reunites Green and Lackritz, at least temporarily, some 20 years after they worked together at the Public Securities Association, now TBMA.
SIA was established in 1972, but fixed-income firms broke away from that organization in 1976 and formed the PSA during fierce debates over the Glass-Steagall Act, which separated commercial and investment banking. In 1987, Lackritz was PSA's deputy executive director and director of government relations and Green joined the group as director of legislative affairs. Lackritz later left the group to become SIA president.
TBMA and SIA officials said that the merger is needed because the markets have changed dramatically in recently years. There has been a convergence of product areas and asset classes, institutional and retail investors and domestic and global markets, they said. The two organizations cover many of the same issues, have many of the same constituents, and deal with the same regulators and legislators, they said.
"The industry model has changed so much," said Forst. "Financial markets in the last 25 years have changed almost beyond recognition."
"So much is changing in this business and in these markets and its driven by technology ... globalization ... and demographics," Lackritz agreed. "I think the convergence in produce areas and asset classes, between the institutional and retail customer and between the domestic and globalized markets all lead you to the conclusion that you need a single powerful organization to most effectively represent both the industry and our many customers."
The expectation is that the new organization will be more powerful than the two separate groups, will save significant costs for members, as well as their time and resources considering the voluntary activities they engage in for the groups. In addition, SIFMA will be able to enhance services for members and will be a much more efficient organization by eliminating overlaps and redundancies that currently exist with the two groups, they said.
"There are obviously some cost savings that will be realized from this merger and some efficiencies....We see a degree of overlap across the organizations," said Gorman, who also indicated there will be some staff reductions. Asked for specific estimates on the cost savings, he said, "We're still working on that. It's still early to put a figure on that."
McKinsey and Co. has been working on proposals to merge the two groups, sources said.
Of the two organizations, SIA appears to have more members and more staff, as well as higher salaries for top officials, but TBMA collects far greater dues and assessments from members and appears to have a bigger overall budget, if less net funds, based on the groups' Web sites, the 990 forms the groups filed with the Internal Revenue Service, and interviews.
SIA has about 605 member firms and a staff of about 134. Lackritz received $1.02 million in compensation and $271,677 in benefits and deferred compensation for the group's fiscal year, which ended Oct. 31, 2005. SIA took in $23.29 million in membership dues and assessments, had revenues of $36.99 million, expenses of $39.24 million and net assets or fund balances of $18.84 million during the fiscal year. The group is based here, but has an office in New York City.
TBMA has 143 full-time members, but 592 total members, including associate members and affiliated firms. It has 123 employees. Green received $900,000 in compensation, $131,966 in benefits and deferred compensation, and $24,759 in expenses for the group's fiscal year, calendar year 2004. Those figures probably rose in 2005. TBMA took in $37.97 million in membership dues and assessments and had $41.99 million of revenue, $37.85 million of expenses and $14.57 million in net assets or fund balances. The group is based in New York, but has offices here and in London.
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Private-Activity: Bonds New Bill Would Allow Tribal Issuance, But Not for Casinos
Posted on Thursday, June 29, 2006
Source: Bond Buyer
By Alison L. Mcconnell
Indian tribal governments would be allowed to issue private-activity bonds, but not for casinos, under federal legislation introduced this week by a pair of senators.
Under current tax law, tribes generally can issue only governmental bonds, but even then only if the proceeds are used in the exercise of an "essential government function," an oft-disputed requirement that tribes and others have sought to clarify as the Internal Revenue Service has conducted a series of audits of tribal bonds. Indian tribes are generally not authorized to issue private-activity debt, but do have access to industrial development bonds.
Sens. Gordon H. Smith, R-Ore., and Max Baucus, D-Mont., introduced the bill, entitled the "Tribal Government Tax-Exempt Bond Parity Act of 2006," on Monday. It would modify the tax code to allow tribes to issue private-activity bonds if 95% or more of the proceeds are used to finance "any facility located on an Indian reservation." It also stipulates that bond proceeds must be used "in the exercise of an essential government function," but makes clear that gaming facilities, such as casinos, could not be financed with tribal bonds.
Smith and Baucus' legislation will likely be referred to the Senate Finance Committee, on which Baucus is the ranking Democrat, but faces an uncertain future from there. Representatives for the two senators did not return calls for comment this week.
Several bills that would have expanded the tax-exempt bonding capabilities of Indian tribes have failed to gain support in recent years.
Most recently, Sen. Tim Johnson, D-S.D., sponsored legislation that would have given all tribal bonds the same tax-exempt status as those issued by state and local governments. It would have allowed tribes to issue private-activity bonds exempt from the volume cap but not for gambling facilities.
Another bill, introduced by Rep. John Shadegg, R-Ariz., would have allowed tribes to sell tax-exempt bonds when 95% of the proceeds were used to finance facilities located within or close to Indian reservations. Similar to Johnson's bill, it also would have allowed tribal governments to issue private-activity bonds if the proceeds were not used for gambling facilities and if 50% of the facility was owned by a non-tribe member. Shadegg had introduced identical bills in the previous two sessions of Congress.
A third bill sponsored by Rep. Dave Camp, R-Mich., was a scaled-down version of one he had introduced in 2002. It would have allowed tribes to issue private-activity bonds for projects on their reservations. Facilities such as golf courses and convention centers would have qualified for tax-exempt financing under Camp's legislation, which had more than two dozen co-sponsors but failed to move forward in Congress.
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SEC: It's Lawyers' Duty to Dig
Posted on Friday, June 30, 2006
Source: Bond Buyer
By Lynn Hume
Bond lawyers have a duty to conduct independent investigations of the facts before rendering tax-exempt bond opinions. That's what the Securities and Exchange Commission told a federal appeals court here yesterday in a brief opposing bond counsel Ira Weiss' appeal of its ruling that he misled investors about a Pennsylvania school district's note issue.
"Weiss complains that 'the commission seeks to impose a freestanding duty on bond counsel to conduct an independent investigation on the facts,' " the SEC said in the 58-page brief it filed with the U.S. Court of Appeals for the District of Columbia Circuit. "Indeed, when rendering an opinion to investors in a securities transaction, a lawyer does have a duty to make an independent investigation," the SEC said.
The commission cited the 9th U.S. Circuit Court of Appeals' 1992 ruling in FDIC v. O'Melveny & Myers that quoted the Securities Law Handbook by H. Bloomenthal: "Attorneys, in rendering opinions relating to the securities laws, are not justified in assuming facts as represented to them by the client and in basing their opinion on the assumption that such facts are correct. Rather ... the attorney must make a reasonable effort to independently verify the facts on which the opinion is based."
The SEC also cited the 2nd U.S. Circuit Court of Appeals' 1973 ruling in SEC v. Spectrum Ltd. that stated: "In the distribution of unregistered securities, the preparation of an opinion letter is too essential and the reliance of the public too high to permit due diligence to be cast aside in the name of convenience. The public trust demands more of its legal advisers than 'customary' activities which prove to be careless."
The current appeals case stems from a Dec. 2, 2005, ruling, in which the SEC found that Weiss was "at least negligent" and violated the federal securities laws in his tax-exempt bond opinion and the official statement for $9.6 million of three-year notes issued by the Neshannock Township School District in June 2000. Weiss issued his unqualified opinion that the notes were tax-exempt, as well as an opinion that there was no misleading information in the OS, without having obtained enough basic information to make those determinations, particularly in the face of questions raised about the deal, the SEC found.
Weiss appealed the ruling Jan. 3. In the petition for review he filed with the D.C. Circuit in late May, Weiss charged that the SEC's ruling was an unprecedented attempt to expand the federal securities laws to cover professional malpractice and that the commission was erroneously contending that Weiss had to "audit" the school district and should have been "a guarantor" of the issuer's compliance with the law.
But the SEC told the appeals court: "This is not a legal malpractice case; the commission held Weiss liable for his own misstatements, not to his client, but to the third party investors. And the problem is not that Weiss relied on client statements that appeared sufficient on their face but which turned out to be inaccurate; rather, Weiss never obtained sufficient information to form a reasonable opinion."
In its brief, which was signed by SEC special counsel John W. Avery, the commission said that Weiss relied on two representations of the school district, "neither of which should have been relied upon by Weiss without further inquiry." School district officials made "vague, inclusive representations" about their intentions to use the note proceeds to finance projects, without specifying which projects, how much they would cost, or when they would be undertaken, the SEC said. Weiss sought a list of the projects and cost estimates, but was able to obtain only a general "wish list" of 33 projects from the school district's supervisor. Though the bonds were issued in 2000, the school district did not begin the projects until 2003, because district board members could not reach consensus on which of the projects should proceed, the SEC said.
Weiss also relied on the school district's non-arbitrage certificate, which cited three tax law requirements that would have to be met for the notes to be tax-exempt. But the certificate was produced by Weiss and signed by an employee who was not advised by Weiss and had no idea what she was signing, the SEC said. Further, Weiss never told the school district about two of the tax law requirements.
The requirements were that the school district: spend at least 5% of the proceeds within six months of issuance; spend at least 85% of the proceeds on capital improvement projects within three years; and proceed with due diligence to complete the projects. Weiss mentioned only the 85% requirement to school district board members.
In addition, the underwriter had pitched the transaction to the school district and board members as an arbitrage-driven deal, in which they could invest the proceeds for three years to earn profits and did not have to spend the money on projects.
All of the school board officials who testified at the hearing before an SEC administrative law judge said either that they thought they did not have to spend any money on projects or that they had the full three years to spend the money. They all said that Weiss did not challenge the underwriter's assertion that the proceeds could be invested for three years.
Weiss also had told the appeals court that the SEC erred in charging him as a "primary violator" of the securities fraud laws rather than as an aider and abettor because the primary misleading document - the official statement - was the issuer's document. But the SEC told the court that Weiss' argument was "meritless" because Weiss approved the OS and he was responsible for the tax-exempt bond opinion upon which investors relied.
Weiss also faulted the SEC for appearing to adopt a "red flag" standard of liability by claiming Weiss failed to address "red flags." But the SEC told the court: "The term red flag appeals only twice in the commission's opinion" and only when someone that the SEC is quoting uses the term.
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May 2006
Reaction to House Tax Plan Mixed
Posted on Thursday, May 11, 2006
By Alison L. McConnell
Are IDAs a Good Deal?
Posted on Monday, May 15, 2006
By Robert Whalen
Legislation: President Bush Signs Long-Delayed Tax Reconciliation Bill Into Law
Posted on Thursday, May 18, 2006
By Alison L. McConnell
Road Privatization's Increasing Popularity
Posted on Thursday, May 25, 2006
By Humberto Sanchez
Panel: Community Support Vital to TIF District Success
Posted on Friday, June 02, 2006
By Tedra Desue
Arkansas Agency Named Best IDB Issuer at CDFA Summit
Posted on Monday, June 5, 2006
By Tedra Desue
Reaction to House Tax Plan Mixed
Posted on Thursday, May 11, 2006
Source: Bond Buyer
By Alison L. McConnell
Market participants had mixed reactions yesterday to a long-awaited conference tax reconciliation bill that went to the House floor last night and is expected to be taken up by the Senate today.
Almost all the tax-exempt bond provisions initially discussed for the bill made it into the main legislation. Conferees pulled back slightly on pooled bond restrictions decried by market groups, adopting a provision instead that requires issuers to reasonably expect to spend 30% of bond proceeds within a year rather than the 50% requirement originally proposed.
Other provisions require pooled bond issuers to have written loan agreements for at least 30% of bond proceeds at the time of issuance, to redeem outstanding bonds with unspent proceeds at the end of the loan period, and to count pooled bonds when determining whether they qualify for the small-issuer exception to federal arbitrage rebate rules.
Conferees also adopted a measure requiring broker-dealers to report all tax-exempt bond interest paid to bondholders to the Internal Revenue Service. The conferees initially planned to put that responsibility on municipal issuers, but market groups convinced them to shift the burden to firms that already report similar information for other obligations.
House lawmakers were debating the $69.1 billion conference bill at press time yesterday and the Senate will likely take it up today. Special budget rules protect the bill from points of order and filibuster on that chamber's floor, so a simple majority is needed to approve it. Lawmakers hope to get the legislation to President Bush's desk by tomorrow.
The compromise bill has been in the works since the House and Senate passed different versions of tax reconciliation legislation late last year. Members of a bicameral conference committee picked to combine the two bills have been at loggerheads for months over a number of tax policy issues.
The final agreement extends the maximum tax rate of 15% for capital gains and dividend income through 2010 and extends through the end of this year a "patch" of the alternative minimum tax, which applies to interest earned on private-activity bonds.
The agreement accelerates an increase in the capital expenditure limit for small-issue industrial development bonds from Sept. 30, 2009, to Dec. 31, 2006. On that date the capital limit will increase to $20 million, from $10 million. The current $10 million bond issuance limit remains.
The bill also expands eligibility for states' veterans mortgage bond programs in Alaska, Oregon, and Wisconsin, but makes no changes for similar programs in California and Texas.
It extends an exception from the arbitrage rules for a portion of the Permanent University Fund, which is used by the University of Texas and Texas A&M University systems to pay debt service on infrastructure bonds.
The legislation would repeal upon enactment a "grandfather" provision that protected 15 sale-in, lease-out transportation deals. The IRS has investigated so-called SILO deals, in which municipalities sell or lease assets to a private entity for cash, and in the 2004 corporate tax bill, Congress outlawed the transactions while grandfathering 15 pending deals into the legislation. The repeal means taxpayers who entered into the deals will not be able to claim tax benefits as the purported owners of assets bought or leased from municipalities.
The conference committee has not yet finalized a deal on a second bill containing roughly $25 billion of tax breaks, including a possible two-year extension of the qualified zone academy bond program.
Most muni market participants agreed yesterday that they did not welcome the pooled bond curbs or the interest reporting requirement, but were pleased that the measures had been scaled back and were less onerous.
"They wanted to tighten some things up in certain areas," said Carol L. Lew, a partner with Stradling, Yocca, Carlson & Rauth and next year's National Association of Bond Lawyers president. "Depending on the type of pool being structured, the restriction may impact some types of issues. The small-issuer elimination is going to impact some decisions."
"While we're extremely appreciative of the change from a 50% requirement to a 30% requirement, we're still very concerned about having the tax-exempt bond provisions in the bill," said Susan Gaffney, federal liaison director of the Government Finance Officers Association. "We wish [there was] a more transparent dialogue and process as to why these provisions are needed."
The interest reporting requirement "is not a revenue raiser; it is a policy change with no discussion between state and local governments and the federal government," she continued. "We need to ensure it's not a costly or administrative burden on state and local governments, then work closely with Treasury as they write the regulations."
"It would have been preferable if this new data flow was not required, but if it is required, certainly it has now been structured appropriately," said Charles A. Samuels, a partner with Mintz, Levin, Cohn, Ferris, Glovsky, and Popeo PC.
The GFOA, National League of Cities, and the National Association of Counties sent a letter yesterday urging House representatives to oppose the pooled bond restrictions.
They also took issue with a provision not included in the original House and Senate bills that would impose what they termed "a new $7 billion tax" that would require the federal and state and local governments to withhold 3% of payments made to non-wage employees.
"It would have been preferable if this new data flow was not required, but if it is required, certainly it has now been structured appropriately," they said. The provision, which would not be effective until 2010, would apply to governments with at least $100 million of annual expenditures.
Market response to the IDB provision, by contrast, was overwhelmingly positive.
"We are ecstatic," said Toby Rittner, executive director of the Council of Development Finance Agencies. "It's been two years of legislative work advocating for this change, which will significantly impact the IDB industry."
And The Bond Market Association's Jill Hershey, senior vice president for legislative affairs, said that while it was unfortunate that revenue raisers were a necessary part of the final package, "the victory is in what was not included."
Joint Committee on Taxation proposals to eliminate advance refundings or limit who purchases municipal bonds were notably absent from the package, and "the extension of an AMT exemption and the acceleration of the IDB capital expenditure limit are most welcome," she said.
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Are IDAs a Good Deal?
Posted on Monday, May 15, 2006
Source: Bond Buyer
By Robert Whalen
How effective are the 116 industrial development agencies operating in New York?
It depends who you ask.
While many state and local government officials praise these agencies for spurring economic activity by providing tax benefits and low-cost financing to private businesses and not-for-profit entities, some labor advocates and government watchdogs question whether taxpayers are getting sufficient return on their investments.
State lawmakers authorized the creation of local IDAs in 1969. Through a range of activities, IDAs were charged with fostering and encouraging local economic growth to "advance the job opportunities, health, general prosperity, and economic welfare" of New Yorkers. IDAs primarily attract and retain businesses through tax breaks and the ability to sell tax-exempt debt.
A study published last week by members of the New York State Initiative for Development Accountability indicates that IDA-sponsored projects don't always create the jobs they promise, create low-paying jobs, or actually cut jobs after receiving tax breaks or low-cost bond financing.
The study also found it troubling that roughly 37% of New York's IDAs didn't have enough data to support a meaningful analysis of whether their economic stimulus programs are generating the jobs and local revenue expected.
"IDAs are useful and important to local development, but this study shows that there are widespread problems with the IDA system and that in many cases, IDAs are not doing the work to economically strengthen our communities," Adrianne Shropshire, executive director of New York Jobs with Justice, which wrote the report, said in a statement.
New York Comptroller Alan Hevesi will publish a new report later this week on the state's IDAs. Hevesi spokesman Dan Weiller said the study would address whether the agencies have procedures to track and verify jobs data, evaluate project performance, and recapture benefits, if necessary. The report will also look at whether IDAs have criteria for awarding benefits to businesses, and whether such criteria are applied consistently, he said.
"We want to get a sense of 'Are they creating the jobs they promise, and if not, do we ask for the money back?' We want to know 'What was the cost and was it worth it? Is this model working?' " Weiller said.
While neither Hevesi nor the state have any direct oversight of local IDAs, the agencies are required to file detailed annual financial data with the comptroller's office. The data, which is made available on the Internet, covers each fiscal year and discloses IDA revenue, tax breaks, bond sales, and payments in lieu of taxes revenue.
The comptroller's latest available data, for fiscal 2003, demonstrates the relevance of IDAs to the municipal bond market. In 2003, the 116 local agencies sold more than $1.7 billion of debt combined.
Not surprisingly, the New York City Industrial Development Agency represented almost half of the 2003 total, selling roughly $843.8 million of debt that year. The IDAs for Long Island's Suffolk and Nassau counties borrowed $152.2 million and $145.6 million, respectively. The Tompkins County Industrial Development Agency, which serves the Ithaca region upstate, sold $101.5 million of debt in 2003, while the Westchester County Industrial Development Agency sold $90.1 million of debt that year, according to the comptroller's data.
New York City's IDA plans to sell up to $1.4 billion of tax-exempt debt this year to help the Mets and Yankees finance new ballparks in Queens and the Bronx. Those bonds will be backed by payments in lieu of taxes to the city's IDA from the teams. The city and the baseball teams are awaiting word from the Internal Revenue Service in response to a private-letter ruling request made in January.
Citigroup Global Markets Inc. will underwrite the bonds for the Mets. Goldman, Sachs & Co. will manage the financing for the Yankees. Nixon Peabody LLP is the IDA's bond counsel.
New York City's IDA, in addition to keeping a busy agenda, does a pretty good job of disclosing its business dealings, according to Bettina Damiani, who closely monitors the IDA as the project director of Good Jobs New York, a labor advocacy and government watchdog group.
"Transparency has greatly improved; we hope the IDA is setting a trend on transparency," Damiani said, noting that the IDA has made the public hearing process more meaningful by making available applications for tax breaks and bond financing in advance of the meetings. "It gives the public the opportunity to reflect on what's being proposed and give intelligent testimony. It has made the public hearing process much more serious ... It's encouraging for the public to know that there's an outlet for them to express their thoughts and opinions."
Damiani credits much of the improvements to IDA president Andrew Alper, a former Goldman Sachs executive who New York City Mayor Michael Bloomberg appointed soon after taking office in 2002. Although Alper announced last week that he was leaving the IDA to work in philanthropy, Damiani said she hopes the spirit of openness continues as a "stepping stone for broader changes" at the agency.
The city's IDA could improve with greater board member attendance at hearings, providing the public more information about its applications process, and disclosing the use of "site consultants" when applicable, she said. Site consultants help companies shop for tax breaks and financing programs made available by various local governments.
This kind of site shopping can pit local governments against each other and prompted state Sen. George Maziarz, a Republican from the state's northwestern edge, to call for some revisions in state IDA law.
Important components of the law are due to expire July 1 and some, such as Maziarz, want to seize the opportunity to improve IDA practices. Maziarz had proposed legislation to "bring some greater accountability to the IDAs, in terms of wage standards and business practices," said Joe Erdman, the senator's legislative director.
Erdman said the Maziarz bill would not increase state oversight or create a centralized bank of IDA data, but would instead require that the individual agencies keep better track of program performance and better coordinate efforts between neighboring jurisdictions, which could help mitigate the negative effects of site shopping.
While Erdman said the senator is "cautiously optimistic" that his legislation may generate some interest and support, the Senate last month approved an IDA bill that would solidify some existing law but fall short of Maziarz's proposals. His bill has been assigned to the Local Government Committee.
Daniel Mac Entee, a spokesman for Sen. Betty Little, who chairs the Local Government Committee, said the measure passed in April is likely the only action state lawmakers will take on IDAs this year.
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Legislation: President Bush Signs Long-Delayed Tax Reconciliation Bill Into Law
Posted on Thursday, May 18, 2006
Source: Bond Buyer
By Alison L. McConnell
President Bush yesterday signed into law the $70 billion tax reconciliation bill that restricts pooled bond issuance, requires broker-dealers to report tax-exempt interest, and moves up the effective date of an elevated limit for capital spending associated with industrial development bonds.
Municipal market groups have alternately applauded and decried the tax package, which had been delayed for months as Congress wrangled over extensions of alternative minimum tax relief and lowered tax rates for capital gains and dividend income. The Senate passed the bill by a 54-44 vote last Thursday after the House cleared it by a 244-185 vote the day before.
A secondary "trailer" bill of tax cut extensions, which could include a two-year extension of the qualified zone academy bond program, has been moved into the pension reform bill, the details of which are being worked out this month by a conference committee. Lawmakers have said they hope to finalize the legislation before they leave for the Memorial Day recess.
The legislation signed yesterday includes provisions that require tax-exempt pooled bond issuers to reasonably expect to spend 30% of bond proceeds within a year and to have written loan agreements for at least 30% of proceeds at the time of issuance.
It requires issuers to redeem outstanding bonds with unspent proceeds at the end of loan periods and to count pooled bonds when determining whether they qualify for the small-issuer exception to federal arbitrage rebate rules.
The law also includes a requirement that broker-dealer firms report to the Internal Revenue Service all tax-exempt bond interest paid to bondholders, and a speed-up of an increase in the capital expenditure limit for IDBs. On Dec. 31 of this year, the limit will increase from $10 million to $20 million, while the issuance limit will remain at $10 million.
In addition, it expands eligibility for states' veterans mortgage bond programs.
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Road Privatization's Increasing Popularity
Posted on Thursday, May 25, 2006
Source: Bond Buyer
By Humberto Sanchez
About $50 billion is in private capital available to be invested in infrastructure finance for states and localities that have had trouble keeping pace with their needs as facilities age and populations increase. As a result, governments are increasingly exploring public-private partnerships, experts said yesterday.
"We did a survey of the amount of dollars that have been set aside over the last three or four years to invest in infrastructure," Mark Florian, chief operating officer of Goldman, Sachs & Co.'s municipal finance and infrastructure group, told reporters before testifying before a House transportation panel. "It's around $50 billion."
His comments come as Transurban, a Melbourne, Australia-based toll road operator, and the Virginia Department of Transportation earlier this month agreed in principle to a concession deal in which Transurban will pay about $525 million in exchange for taking over the Pocahontas Parkway for 99 years, including operations, maintenance, and collection of toll revenue.
The comments also come as Indiana leased the Indiana Toll Road to Australia's Macquarie Infrastructure Group and Spain's Cintra Concesiones de Infraestructuras de Transporte, which agreed to operate the toll road under a 75-year lease agreement in exchange for $3.8 billion.
Florian explained that private participation in U.S. infrastructure financing is an evolving phenomenon and provides a third option to paying for infrastructure through tax increases and traditional tax-exempt bond financing.
"Whether there will be more leaders like [Virginia and Indiana] that will drive this forward is still an open question," Florian said.
Private companies can also use up to $15 billion in tax-exempt private activity bonds to finance the construction of highway projects and rail-to-truck freight transfer facilities, under pilot program included in transportation legislation enacted last summer.
While no projects have yet sought a bond allocation there has been interest in the program, Florian said.
Texas is "evaluating the applicability of private activity bonds" to road projects the state plans to build, Florian said in written testimony before the House Transportation and Infrastructure Committee's highways and transit subcommittee.
"It may be the case that the State of Texas is able to utilize these federal funding techniques in combination with a" public-private partnership, he added.
Goldman Sachs, which has been on the leading edge of the public-private partnership trend, was hired in October 2005 by the Texas Department of Transportation as a "concession advisor" to assist with various road financing projects, including state highway 121 in Collin and Denton counties.
Along with advising on the Indiana Toll Road, the firm also is currently serving as financial advisor to Utah for the Mountain View Corridor, a 40-mile new highway project connecting I-80 west of the Salt Lake City Airport, according to Florian. The project is expected to cost between $1.5 and $2.5 billion. Funding for the project is still being determined and tax-exempt bonds and private concession deals are both being explored.
Most recently, Goldman Sachs and an Atlanta-based engineering firm proposed building a truck-only road next to Interstate 285, which could be financed with bonds or leased to a private company.
The $50 billion pool of private investment capital, which has formed over the last five years, is the result of investors - typically pension funds and insurance companies - seeking investments that are riskier than municipal bonds, but not as volatile as stocks and equities.
"What has happened is that there are pension funds and other pools of capital that are very interested in investing in long-term assets that are very steady in term of their performance at producing cash flow," Florian said. "These folks are willing to accept lower rates of return than they might normally get in the stock or other investment vehicles. They are willing to [accept less] because they want that steady, less volatile type of investment."
Capital has been made available from the likes of the Ontario Teachers Pension Plan, which, he said, is seeking about 10% of their overall portfolio in infrastructure.
"One slice of a portfolio like that could be as much as $6 billion," Florian said. "There are many others that have [also] decided that they want this as an investment vehicle."
Govs. Timothy M. Kaine of Virginia and Mitch Daniels of Indiana also testified before the subcommittee.
"Not every highway expansion project is a candidate for public-private financing," Kaine told the panel.
Increased private participation in transportation infrastructure financing could help address about 20% of Virginia's transportation infrastructure needs, he said. However, private deals are difficult to do in rural areas, where there may not be enough traffic to draw private interest, he added.
Daniels said that the $3.8 billion Indiana Toll Road concession deal allowed the state to finance nearly $5 billion of other badly needed road projects that it could not have done otherwise. The $5 billion figure includes the $3.8 billion, plus the $900 million in interest it will earn.
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Panel: Community Support Vital to TIF District Success
Posted on Friday, June 02, 2006
Source: Bond Buyer
By Tedra Desue
While tax increment finance districts have become a popular tool to help rid communities of blight and spur economic development, they are still often resisted by those unfamiliar with their complexities.
For that reason, municipalities wishing to create TIFs should work to make sure they have sufficient community buy-in before moving forward. That was the message to those attending the Council of Development Finance Agencies' pre-summit workshop here on Wednesday.
Cheryl Strickland, managing director of tax allocation districts for the Atlanta Development Authority, advised the group of several steps they could take to drum up support. In Georgia and some other states, TAD is the preferred name for the districts, which allow cities and counties to freeze existing property values within a district's boundaries and collect the incremental increases to back debt.
Strickland told the group that obtaining community support for the districts was as important as gaining the support of the local governing bodies.
Atlanta learned that lesson anew with the creation of its latest and largest TAD -- the BeltLine, a massive redevelopment district that encircles the city. Although Atlanta had already created five TADs and sold more than $400 million of bonds for them, it seemed organizers nearly had to start from scratch to get the necessary approvals for the BeltLine. Fulton County, which is home to the city, and the Atlanta Board of Education had to agree to give up the incremental taxes that would come from the TAD's creation.
Residents came out in droves to voice their concerns about the project to the City Council. Some council members also balked at the huge development, which is expected to lead to more than $1 billion of bonds being sold over the next several years.
"You should start to go out and talk to the community even before you go to your City Council for approval," Strickland said. "We've learned a lot about how we can do things better."
Also important is being flexible enough to make the necessary concessions to get the deal done. Strickland noted that for Atlanta's TADs, the city agreed to certain projects requested by the county and the school board.
In fact, earlier this year the city had to agree to take on more jail inmates from the county as part of a deal to buy a key piece of property for the BeltLine. Fulton County has been under the gun to reduce overcrowding in its jails, so several commissioners would agree to the sale of the land only if Atlanta agreed to house 500 inmates.
The CDFA is putting together a best-practices guide incorporating the issues discussed at the seminar so that issuers can a have central source to get information. Wednesday's half-day event was the first of many planned this year that will focus just on TIFs. The CDFA plans another seminar for November in Baltimore.
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Arkansas Agency Named Best IDB Issuer at CDFA Summit
Posted on Monday, June 05, 2006
Source: Bond Buyer
By Tedra Desue
Attendees at the Council of Development Finance Agencies' annual summit here on Friday chose the Arkansas Development Finance Authority as the best industrial development bond issuer.
The award, which was the part of the council's Practitioner's Showcase, was a first for the agency, and its presentation marked the end of CDFA's 2006 summit.
The ADFA's bond guaranty program was among four finalists selected by the CDFA. The others included the Massachusetts Development Finance Agency's "Mass Development" tax-exempt IDB program; the Minneapolis Community Planning and Economic Development Department's bank-qualified, bank-direct tax-exempt loan program; and the Los Angeles Industrial Development Authority's IDB program.
Arkansas won after a live audience vote. The criterion for voting was simple: which issuer's program best exemplified how to use IDBs for economic development?
Attendees heard extensive presentations from each of the finalists before voting.
Gene Eagle, vice president of economic development for the ADFA, noted that while the program is unique, issuers might find some of its components worth exploring.
He told the group that applicants to the program pay guaranty fees that are deposited into a reserve account that is used to make debt service payments. He also noted that the authority has the power to replenish the reserve fund by issuing new guaranty bonds, and that the debt service on those bonds is paid directly by the state.
One of the authority's last deals was in November when it issued $40.5 million of facilities revenue bonds. Proceeds from the deal financed the construction of and equipment for a special-needs unit located adjacent to the Arkansas Department of Correction's Ouachita River Unit in Hot Spring County. The new facility will add beds for inmates with mental or physical disabilities, terminally ill or geriatric inmates, as well as those who pose a danger to themselves or others. The facility also will include a diagnostic intake center to process new inmates before placing them within the system.
Since the program's inception in 1985, more than 150 projects have been completed that were funded with more than $218 million of bonds.
Toby Rittner, the executive director of the CDFA, said that the idea for Practitioner's Showcase was to allow others to see how their colleagues were forging ahead through the use of IDBs.
Last week's summit was the largest ever for the CDFA, and staffers are already planning more seminars for this year.
Rittner said the next will be in Baltimore on Nov. 7 and the topic will be tax increment finance districts. The CDFA has spearheaded an effort to set guidelines that issuers throughout the country can draw on in determining how to set up the districts, which are also called tax allocation districts.
At the November meeting, the goal will be to start assembling the ideas that have come from TIF experts across the country. Rittner said he hopes to have the best practices guidelines for TIFs available by the end of the year.
The CDFA is a national group that lobbies on behalf of state and local governments and municipal authorities that provide economic development finance programs.
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April 2006
CDFA is proud to offer the following monthly news articles courtesy of The Bond Buyer. This feature is part of CDFA's strategic partnership with The Bond Buyer. CDFA selects five important articles to feature each month from the previous months daily publications. These articles remain the property of The Bond Buyer. Please contact The Bond Buyer to arrange any reproduction of these articles.
Alaska Aims to Lure Buyers With 'Fish' Deal
Posted on Monday, April 10, 2006
By Rich Saskal
Privatization in N.J.?
Posted on Monday, April 10, 2006
By Adam L. Cataldo
IDBs: CDFA Selects Four Finalists for 'Best Issuer' Award
Posted on Monday, April 17, 2006
By Alison L. Mcconnell
NABL Submits Comments on Derivatives to Treasury Dept.
Posted on Monday, April 17, 2006
By Alison L. Mcconnell
Legislation: FHLBs Could Offer LOCs for Economic Development Debt Under Bill
Posted on Wednesday, April 26, 2006
By Alison L. Mcconnell
Alaska Aims to Lure Buyers With 'Fish' Deal
Posted on Monday, April 10, 2006
Source: Bond Buyer
By Rich Saskal
Alaska is selling about $67 million in revenue bonds this week backed by what is believed to be an unprecedented revenue source.
The bonds, which will finance construction of two fish hatcheries, will be repaid with revenue from fishing licenses.
"To the best of my knowledge, this is the first use of a fish and game surcharge and license fee to provide for an improvement to benefit the fishers in that state," said Deven Mitchell, Alaska's debt manager.
"I think it's a very unique credit and that's what makes it exciting," said Freda Johnson, president of Government Finance Associates, the state's financial adviser.
The bonds price Tuesday after a retail order period today. Merrill Lynch & Co. will be lead underwriter.
Alaska plans to build a modern hatchery in Anchorage to replace two older facilities, and build a brand-new hatchery in Fairbanks. The state releases over seven million fish annually from its hatchery program, which has the objectives of improving fishing opportunities, reducing pressure on wild stocks, and providing diversity to the angling and viewing public, according to the state Department of Fish and Game.
The two Anchorage hatcheries have relied on military power plants to supply waste heat to create the warm water needed for the hatchery process. Those power plants went off line in 2004 and 2005, encouraging the state to design a more modern hatchery that will require less heat and water consumption.
By building a hatchery in Fairbanks, state officials also plan to reduce the current need to transport hatchery fish to the Interior from Anchorage.
Hatchery operations are already funded with fishing license fees, and the bonds will allow the capital needs of the hatchery program to be user-financed.
The program was enabled by a bill the Legislature approved in 2005, enacting a surcharge to fishing license fees and authorizing the state to bond against it.
Alaska residents are paying a $9 surcharge on their $15 annual sport fishing license, while the surcharge for non-residents is between $9 and $45 above the base fee, depending on the length of the license.
The bonds will be insured by triple-A CIFG Assurance North America, further bolstered by single-A level underlying ratings.
"We had a pretty positive ratings process where we wound up achieving the exact kind of ratings we were hoping for," Mitchell said.
The deal achieved underlying ratings of A2 from Moody's Investors Service and A from both Standard & Poor's and Fitch Ratings.
The rating goal was achieved in large part with the use of conservative revenue projections.
There will be ample debt service coverage even if the issuance of fishing licenses remains at the 2003 level, said the Standard & Poor's report authored by analyst Gabriel Petek - but license sales have actually been growing steadily, with a 9.2% increase over the 2003-2005 period.
In addition to the pledge of revenue from the surcharge, which is expected to fully cover debt service, the state also pledges revenue from the basic fishing license fee, fees from king salmon stamps, and federal grant revenue.
The conservative debt-coverage structure also offers the state a path toward early repayment of the debt should license sales continue to increase, Mitchell said.
"It has a 20-year structure, but were going to have some additional call options on some of the bonds," he said. "There will be a piece with a three-year call, some with a seven-year call option, and the balance with the standard 10-[year call]," he said. "There'll be a little more yield paid because of those call provisions but it gives us flexibility because of possible future fluctuations in revenue flows."
Preston Gates & Ellis LLP is bond counsel. Birch, Horton, Bittner and Cherot is underwriters' counsel.
While the deal is estimated at about $67 million, the final par could reach $69 million, depending on how premium bonds and discount bonds fit into the picture, Johnson said.
"We'll probably have a mix of both, but obviously we won't know until next week," she said last week.
Mitchell said the deal has required more of an educational effort than most.
"People aren't familiar with it and just can't let it flow into their portfolios," he said in a statement that underlined another occupational hazard of working on a fishing-based bond deal.
"It also provided a great opportunity for a lot of bad jokes," he said. "Everyone was trolling for something."
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Privatization in N.J.?
Posted on Monday, April 10, 2006
Source: Bond Buyer
By Adam L. Cataldo
Will New Jersey privatize Main Street?
State officials and public finance professionals have discussed privatizing the New Jersey Turnpike for almost a year amidst the recent trend of toll road privatizations in the U.S. The talks come as New Jersey is wrestling with a budget deficit of about $4.5 billion, and the financially strapped state is facing multi-year spending commitments for education, transportation, and its pension system.
Sen. Raymond Lesniak, D-Union, made the first formal pitch to privatize, at least partly, turnpike assets by selling a minority stake for a combination of debt and equity. Lesniak's proposed bill, which he described as a "very preliminary" draft, would have the state sell a 49% stake in turnpike assets. Lesniak floated the idea as a way to start the discussion on privatization, he said, adding that he is open to revisions. The bill has not yet been submitted to the Legislature.
"It's a more gradual approach to the state getting involved in privatization," Philip Villaluz, a municipal credit analyst with Merrill Lynch & Co., said about the idea of selling stock. "I equate that to the state dipping its toe into the privatization pool."
The New Jersey Turnpike Authority owns and operates two of the most potentially lucrative toll roads in the country: the 148-mile New Jersey Turnpike, commonly referred to as the state's Main Street, and the 173-mile Garden State Parkway.
A sale or lease of New Jersey's two main North-South roadways could generate billions of dollars of revenue for the state.
"The new corporation would issue $10.4 billion of non-recourse [taxable] debt and there would be no liability to the state," Lesniak said. "The sale of the stock is anticipated to raise $1 billion. That gives the corporation $11.4 billion in exchange for the concession agreement, and the turnpike gets the $11.4 billion. It pays its existing $5.4 billion of debt. It pays that off. Which leaves $6 billion for the state of New Jersey and less debt," Lesniak said.
According to the authority's 2004 annual report, the authority collected nearly $716 million in toll revenues, and had total revenues for the year of $829 million. Revenue paying vehicles totaled more than 856 million, traveling more than 12.6 billion miles.
Moody's Investors Service rates the authority A3, Standard & Poor's rates it A, and Fitch Ratings rates it A.
At the same time, the state could generate additional revenue for itself by increasing tolls. According to a report by Villaluz, the Turnpike is one of the least expensive toll roadways in the country, charging drivers 5.5 per mile. The Parkway is the cheapest toll road in the country charging drivers 2.2 cents per-mile.
Lesniak said the idea for the legislation is based on a proposal brought to him by a Wall Street firm. The authority did not return repeated telephone calls seeking comment about the proposal.
"There are handful of people that have made various proposals with regard to the turnpike, but only one that is a proposal that is a partial sale that I'm sponsoring right now," Lesniak said. "But all the concepts are very similar."
Lesniak said the idea started with proposals that began floating around last year to sell the entire turnpike. Lesniak said he is against turning over maintenance and safety of the state's most critical roadway to a private entity. The plan is based on a proposal that a particular firm brought to him that takes into account his objections to selling control of the turnpike to a private entity.
Lesniak said this proposal would allow the state to keep and maintain control of the turnpike retaining a 51% share. The stock would remain outstanding for 75 years.
"This model's assumption was that from 2010 on tolls would have to increase every year up to an amount not to exceed the consumer price index increase. It doesn't necessarily have to do that but it would be more in tune to achieving targets that are fixed, and target a return on investment of 9%," he said. "The reason 9% was used was because that was what folks think the market will demand, and that yields $6 billion. If we could sell the stock with a targeted return of 5% we would get $12 billion or $11 billion, but no one thinks any one would buy it at that rate of return."
The turnpike authority would establish a for profit corporation that would issue shares. A majority of the corporation's board of directors are to "be selected from among or by the members of the authority," according to the proposal. While Lesniak initially referred to the stock that would be sold in the turnpike as preferred stock, he said that might not be the most accurate term available. In an interview Friday, Lesniak described the securities to be sold as common stock.
"I am not a financial expert. But I was basically just saying that his would be, after expenses and revenues, what was left would go to shareholders," Lesniak said.
Lesniak said that by selling stock instead of bonds it saves the state from having to guarantee a rate of return.
"The reason it is structured that way is that it would have a limited impact on the operations of the turnpike," he said. "They are based on revenue assumptions and certain modest increases, consumer price increases. So that is the difference."
How the use of the depreciation value of the roads will be used is still unclear.
"It depends on whether or not we do an IPO or a private placement and that hasn't been decided yet, how it's structured," Lesniak said. "If it's a private placement some accelerated depreciation will be allowed to the shareholder. If it's an IPO it goes to the corporation,"
Lesniak has proposed that any money realized from the sale go to pay a portion of the state's unfunded pension liability. The state's owes about $8.6 billion to it pension funds.
A spokesman for Gov. Jon Corzine said in a statement that the governor wants any funds earned from a privatization deal to be used for funding long-term capital improvements or paying down debt. Corzine is studying the impact of both the Chicago Skyway and Indiana Toll Road deals.
Chicago last year entered into a private concession contract handing over operational rights of the Skyway toll road to a private operator as part of a 99-year lease that raised $1.82 billion. Indiana Gov. Mitch Daniels has signed legislation to enter into a 75-year contract leasing the state's toll roads for $3.85 billion.
"The governor has said very clearly he wants to evaluate these kinds of transactions like the one Indiana has done to see what the toll structure there is. He also wants to see what the capital improvements that were planned prior to the sale of the Indiana toll road and what happens now," said Kris Kolluri, the head of the state's Department of Transportation. "It's too soon to decide how that is working out. The governor has said consistently that he wants to see how that experiment is working out before he makes a decision on whether that is appropriate for New Jersey or not."
According one person familiar with transportation deals in New Jersey, speaking about the stock portion of the proposed transaction, said that structure being proposed makes sense from a financing perspective with a potential upside in terms of equity for investors.
"You are subordinated as to payment of debt but you would be preferred as to liquidation. So you are going to get paid out par for instance and get taken out. You get your share, maybe you get a pro rata share of sale proceeds if and when they sell it. So you are going to get paid out a portion of the sale proceeds before the state for instance," he said. "That is how I am looking at it. That is sellable."
As an example, he talked about the potential of New York State selling a 49% share in the Tappan Zee Bridge. Shareholders would receive a regular payment from the state. If the state later decided to sell the bridge outright, minority shareholders would then realize an even greater return over their original investment by receiving 49% of whatever the bridge is sold for.
"That is what we haven't been dealing with in our market: The understanding of the equity value of these assets," this person said. "But it's there. There is equity value."
Interest in privatization jumped after a report issued last year estimated that New Jersey could earn $25 billion to $30 billion from sale of its toll roads.
Merrill Lynch's Villaluz, who wrote that report, said that while selling stock is basically a good idea, it is one that raises a whole series of questions in comparison to full privatization.
"As far as the proposal to allow 49% investor ownership of the turnpike, from the perspective of the foreign toll road investors, that may not be necessarily as attractive as a business venture in that they don't have the controlling interest in the toll road or the ability to ramp up toll rates and control the operation where they would be allowed to generate operating efficiencies," Villaluz said.
A more attractive investment would for toll road operators would be to finance the purchase on their own, and then pay back the debt and invest their own capital equity into the project. The proposal also puts restrictions on the rate that tolls can increase.
"Typically what they have done with Chicago Skyway and the Indiana Toll Road was they give them the flexibility to set toll rate increases to the greater of 2% CPI or nominal GDP on a per-capita basis. Nominal GDP per-capita has historically been higher than CPI, and much higher than 2%."
Villaluz said the minimum allowed for toll rate increase in the Indiana deal is 2%, while average consumer price index is about 4%. However, the operator is allowed to set toll rate increases to the increase in nominal gross domestic product per-capita which has averaged 5.5% since 1987.
"Now if you are limited to only CPI that brings down the rate of how quickly you can increase your tolls," he said.
Villaluz said Italy's Autostrade Group, a toll road operator, has done privatizations in Europe that have left the state with controlling interest. Complete investor ownership of toll roads in Europe has only begun to occur in recent years.
Villaluz said he thinks accessing the capital market for money is better from a financial perspective than issuing more debt.
"It's difficult to garner support for taking on more debt," Villaluz said.
New Jersey's toll roads, like many large roadways around the country, already have a significant amount of debt outstanding given their revenues, Villaluz said. In a report issued last year, Villaluz noted that the authority was considering a widening and connector project for the turnpike that is estimated to cost $1.9 billion.
"I would consider that a fairly significant amount given the amount of debt that is already on their books," Villaluz said.
What the proposal does do is help to further the discussion of privatization, Villaluz said. And at this point, sale of minority interest the toll roads may be the only deal that elected officials and the public are willing to accept.
"I think it is apparent that both the Turnpike and the Garden State Parkway is a tremendously under-utilized asset of the state as far as the revenue generation," Villaluz said.
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IDBs: CDFA Selects Four Finalists for 'Best Issuer' Award
Posted on Monday, April 17, 2006
Source: Bond Buyer
By Alison L. Mcconnell
Building up to its annual development finance summit and the first-ever "Practitioner's Showcase" for municipalities that sell industrial development bonds, the Council of Development Finance Agencies has selected four finalists for "Best IDB Issuer."
And the nominees are: the Massachusetts Development Finance Agency's "Mass Development" tax-exempt IDB program; the Minneapolis Community Planning and Economic Development Department's bank-qualified, bank-direct tax-exempt loan program; the Los Angeles Industrial Development Authority's IDB program; and the Arkansas Development Finance Agency's bond guaranty program.
The four organizations will make presentations at the CDFA's annual summit, which is scheduled for June 2 in Austin. A live audience vote will determine the winner.
"The showcase will be a demonstration of the very best in the IDB finance industry [and focus] on creating deal flow, marketing programs, executing projects, and raising awareness of this important economic development finance tool," CDFA executive director Toby Rittner said in a statement yesterday.
The four finalists are "some of the industry's most knowledgeable leaders," he said, and were picked by a five-person selection committee that consisted of three issuers, a bond counsel, and an underwriter.
The CDFA is a national group that lobbies on behalf of state and local governments and municipal authorities that provide economic development finance programs.
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NABL Submits Comments on Derivatives to Treasury Dept.
Posted on Monday, April 17, 2006
Source: Bond Buyer
By Alison L. Mcconnell
Issuers should have up to three months to make payments associated with simple integration of interest rate swaps with tax-exempt bonds, and should be able to make yield reduction payments to comply with yield restriction rules, the National Association of Bond Lawyers told the Treasury Department last week.
A NABL task force submitted those and other comments Thursday regarding the qualified hedge rules, which apply to interest rate swaps and other derivative products often used in the muni market. The task force made the recommendations because of significant growth in the use of derivatives over the past decade and wanted to address "everyday" issues faced by practitioners, according to its chairman.
The group said Treasury should provide guidance for establishing an issuer's reasonable expectations that the floating rate on a swap will be substantially the same as the floating rate on the related bonds.
The recommendations originated in a dialogue that began over a year ago between NABL members and various Treasury, IRS, and SEC officials, who were trying to be "mutually helpful, cooperative, [and] collegial," said task force chairman Willis Ritter, an attorney with Ungaretti & Harris LLP here.
"We spent a great deal of time last fall identifying a substantial number of issues, probably 15 or 20. From those, we narrowed it down to the four or five covered in the comments," said Ritter, a former Treasury official.
Interest rate swaps and other derivative products used to hedge interest rate risk on municipal bonds are subject to the arbitrage rules of the tax code. Additionally, the integration of interest rate swaps with related bonds is a process subject to a set of requirements -- the qualified hedge rules.
Eight conditions must be met in order for a swap to be a "qualified hedge" and thereby to have terms that may be integrated with those of the underlying bonds for yield calculations, a situation known a simple integration.
In simple integration, variable-rate bonds subject to an integrated floating-to-fixed rate swap are treated as variable-yield bonds. For variable-yield issues, bond yield must be calculated at least once every five years if any bond proceeds are subject to arbitrage investment yield restrictions. "Super" integration has a separate set of requirements that allow bonds to be treated as fixed-yield bonds.
The NABL task force commented on four principal issues in its report to Treasury, the first of which was simple integration in connection with variable-rate advance refunding bonds.
The tax code dictates that for such transactions to comply with yield restrictions, the variable bond yield must be no less than the escrow yield. Problems arise when the bond yield cannot be determined with precision at closing, the task force said. If the escrow yield exceeds the bond yield, the issuer must either restructure the escrow investments as needed during a computation period or invest funds in a sinking fund.
"This process of managing the escrow is costly and time-consuming," NABL said, adding that for escrow periods longer than five years, is unclear whether the bond yield should be calculated separately for all computation periods or if such periods should be blended together until the end of the escrow.
"One solution would be to allow a computation period, applicable only to variable-yield advance refunding bonds swapped to fixed under a qualified hedge, which ends on the last date that escrowed funds are applied to pay or redeem the prior bonds," it suggested.
Regulations should be further revised to permit yield reduction payments in situations where the floating amounts received under swaps exceed the corresponding floating amounts paid on bonds, which renders the bond yield lower than that of the escrow, the task force said.
Such yield reduction payments could be paid directly to the federal government at the end of the escrow period and permitted "only if, as of the sale date of the bonds, the escrow yield is less than the fixed rate payable by the issuer under the swap," it said.
The task force next addressed the degree of correlation required between the floating leg of a swap and the floating rate payments on the related bonds, arguing that differences in bond and swap market conventions -- and in issuers' abilities to change interest rate modes -- result in payments on different dates.
Payment timing provisions of a swap cannot accommodate changes in the interest rate mode on the bonds without an amendment of the swap contract, it said.
Since a 15-day period of separation is currently permitted for payments on super integrated bonds, a less tight period -- such as three months -- should be established for simple integrated bonds, the task force recommended.
Task force members also suggested Treasury provide guidance for establishing an issuer's reasonable expectations under the requirement that the floating rate on a swap will be substantially the same as the floating rate on the underlying bonds for super integration, including whether it is reasonable to base future expectations on a historical result.
If Treasury thinks it is unreasonable for issuers to assume static tax law for the term of a hedge, "any historical comparison test to demonstrate an issuer's 'reasonable expectations' becomes unworkable, and super integration would seem to be unachievable using a [London Interbank Offering Rate]-based swap," it said.
Regarding the integration of multiple hedges, the task force recommended that tax code rules be clarified to apply to "synthetic" bonds already subject to a qualified hedge in an effort "to make super integration more readily available, or at least more comprehensible," Ritter said. "Right now nobody knows how to safely achieve [it]."
The task force also addressed the requirement that qualified hedges be identified on the books of issuers within three days, suggesting that the period be extended several more days and that conduit borrowers also be allowed to identify hedges in their books.
Ritter said the task force was "rather hopeful that the Treasury will listen to" the recommendations, which he said were issues encountered in day-to-day practice.
"None of them makes a nickel's worth of substantive difference in the transactions," he said "Now that this market practice has matured ... we hope that the regulations can reflect and coordinate with the way business is done in normal without being artificial about it.
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Legislation: FHLBs Could Offer LOCs for Economic Development Debt Under Bill
Posted on Wednesday, April 26, 2006
Source: Bond Buyer
By Alison L. McConnell
The Federal Home Loan Banks could provide credit enhancements to issuers of tax-exempt economic development bonds under legislation proposed this week by Rep. Phil English, R-Pa.
English's bill is similar to previous ones introduced in Congress after the Internal Revenue Service began auditing deals in which the banks had issued what it dubbed "illegal federal guarantees" on the bonds.
His legislation would amend the federal tax code to allow bonds guaranteed by the banks to be treated as tax-exempt. Under the tax code, only housing bonds can be backed by a federal guarantee and still retain their tax-exempt status.
English's bill would apply to bonds sold after enactment, leaving previously issued debt uncovered and still open to IRS scrutiny.
While the bill would authorize the banks to provide various credit enhancements to municipal issuers, it was written mainly to clear the way for letters of credit, English said in an interview Monday.
The legislation would lower borrowing costs by allowing state and local governments to obtain a performance guarantee from a triple-A rated entity, and would put the FHLB system on the same level as Fannie Mae and Freddie Mac, who are permitted to issue LOCs in support of tax-exempt bonds, he said.
"It's a whole range of credit needs for municipalities that have been experiencing a financial deterioration," said the congressman, a former city controller for Erie, Pa. "I spent a great deal of time working on financial credit issues in a third-class city at a time when we were going through financial crisis. So these are fairly familiar issues to me."
While the bill is particularly geared for older cities that have limits on their tax base and "high risk" credit cities, it also has wide applicability to all municipalities, according to English.
"This is an immensely helpful role for the FHLB to be able to step into, to give relief to cities that have significant challenges in meeting their infrastructure needs," he said. "This is a tool that would be available to any city that wants to sit down with the bank, acting in effect as a co-op with the banking community. [It] basically gives the banks the ability to put together these packages with the benefit of a letter of credit that will fly with the marketplace."
English said it was "natural" for the Federal Home Loan Banks to help underwrite infrastructure investments.
"After all, municipal infrastructure is as central as housing itself, and is directly connected [to] how neighborhoods are put together and accordingly can be revitalized," the congressman noted.
Municipal groups have expressed their support for this proposal along with similar bills that preceded it but died in Congress.
"It is in the interest of cities to have as many institutions as possible eligible to provide credit enhancements for tax-exempt bonds," Donald J. Borut, executive director of the National League of Cities, said in a letter to English earlier this month.
An FHLB spokesperson said this week that the Pittsburgh, New York, and Indianapolis banks were "taking the lead" on pushing for English's legislation on Capitol Hill. The banks are maintaining the supportive position they have espoused for years, the spokesperson said.
English was planning to introduce the bill on the House floor sometime yesterday afternoon, said press secretary Julia Wanzco. A bill number had not been assigned at press time.
The IRS' interest in standby LOCs issued by FHLBs and backstopping tax-exempt economic development bonds was sparked about four years ago. While some deals had secondary issues, the agency's major concern was whether the letters of credit constituted illegal federal guarantees of the bonds.
In past years, some of the 12 regional banks aided the housing bond market by buying either taxable or tax-exempt bonds directly from housing agencies and providing LOCs to enhance mortgage revenue bonds. But some of the banks extended the practice to other types of economic development bonds - a practice the IRS contends violates the tax code.
The IRS encouraged issuers to come in via the voluntary closing agreement program at the time. It settled roughly seven examinations and reached a number of VCAP settlements after the round of audits was opened, according to tax-exempt bond office field manager Charles Anderson.
Since then, the IRS' position "has not changed at all," he said.
"I think that people have become more aware of indirect federal guarantees, and the bill seems to support our treatment in that it seeks legislation to change it," Anderson said.
English and others have argued that a Federal Home Loan Bank's letter of credit does not constitute a federal guarantee of tax-exempt debt because it does not transfer credit risk to the federal government. The banks, while federally chartered, are privately owned.
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